“Should I prepay my home loan or invest the extra money?” is one of the most common financial questions. The confusion happens because people compare guaranteed interest savings with uncertain market returns without adjusting for tax, tenure, and risk.
The answer is not emotional. It is mathematical. Once you calculate your loan interest rate, expected investment return, and time horizon properly, the break-even number becomes clear.
Instead of guessing, use a structured framework.
Understand Your Loan Cost Clearly
Your home loan interest rate is your guaranteed cost of capital. If your loan rate is 8.75%, prepaying effectively gives you a risk-free 8.75% return.
Here is how total interest changes on a ₹50 lakh loan over 20 years:
| Interest Rate | EMI (Approx) | Total Interest Over 20 Years |
|---|---|---|
| 8.50% | ₹43,391 | ₹54.1 lakh |
| 8.75% | ₹44,137 | ₹56.6 lakh |
| 9.00% | ₹44,986 | ₹59.9 lakh |
A 0.50% rate increase adds nearly ₹5–6 lakh over tenure. That is why loan cost must be your starting point.
Calculate the Prepayment Impact
Suppose you prepay ₹5 lakh in year 3 on an 8.75% loan with 17 years remaining.
Approximate interest saved over tenure: ₹6.5–8 lakh depending on tenure reduction method. That means your effective return on that ₹5 lakh is equivalent to 8.75% compounded over remaining years.
Prepayment delivers guaranteed savings. There is zero market risk.
Now Compare With Investment Returns
If you invest ₹5 lakh into equity mutual funds with expected long-term return of 12%, the comparison becomes:
| Option | Return Type | Expected Outcome (15–17 yrs) |
|---|---|---|
| Prepay Loan | Guaranteed 8.75% saving | ~₹6.5–8 lakh saved |
| Invest @ 12% | Market-linked | ~₹27–30 lakh future value |
| Invest @ 10% | Market-linked | ~₹20–22 lakh future value |
However, this assumes you stay invested for full tenure and markets deliver consistent compounding.
The Break-Even Rule
The decision rule is simple:
If your expected post-tax investment return > loan interest rate by at least 2–3%, investing usually wins long-term.
If your loan rate is high (9%+) and you are risk-averse, prepayment often makes more sense.
If you cannot tolerate volatility or might withdraw early, prepayment is safer.
Tax Angle Changes the Equation
Home loan interest offers tax deduction under Section 24 up to ₹2 lakh annually (subject to conditions). If you fall in 30% tax slab, effective loan rate reduces.
Example:
Loan rate: 8.75%
Tax benefit (approx effective reduction): 1.5–2% depending on usage
Effective cost may drop to around 6.75–7.25%
In such case, equity investment with long-term return expectation of 11–12% clearly beats prepayment mathematically.
Always compare post-tax numbers, not headline rates.
When Prepayment Makes More Sense
Prepayment is stronger when:
-
Loan rate is above 9%
-
You are near retirement
-
You value debt freedom psychologically
-
Your equity allocation is already high
-
Market valuations are stretched
Debt reduction reduces financial stress and improves monthly cash flow.
When Investing Makes More Sense
Investing usually wins when:
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You have 10+ year horizon
-
You can tolerate market volatility
-
Your effective loan cost after tax is below 7%
-
You are disciplined with SIP
-
You will not withdraw midway
Compounding over long duration favors investments if returns exceed loan cost meaningfully.
Hybrid Strategy: Often the Best Answer
Instead of choosing one side fully, many investors split surplus.
Example strategy:
-
50% surplus to SIP
-
50% to prepayment
This reduces loan tenure while maintaining long-term wealth compounding. It also balances psychological comfort and mathematical advantage.
Decision Table Based on Scenario
| Scenario | Suggested Action |
|---|---|
| Loan rate > 9% | Prioritize prepayment |
| Loan rate 7–8% + long horizon | Invest |
| Near retirement | Prepay |
| High risk tolerance + 15 yrs left | Invest |
| Short tenure left (<5 yrs) | Prepay |
This removes emotional bias.
Conclusion
The prepay vs invest debate ends when you calculate break-even correctly. Compare loan interest rate with realistic post-tax investment return and your risk tolerance. If investment return comfortably exceeds loan cost and you have long horizon, investing usually builds more wealth.
If stability, certainty, and debt reduction matter more, prepayment delivers guaranteed return. The right answer depends on your numbers — not generic advice.
FAQs
Is prepaying loan always safer?
Yes, it offers guaranteed return equal to your loan rate. However, it may not maximize wealth compared to higher-return investments.
How much higher should investment return be to beat loan prepayment?
Ideally 2–3% higher than your effective loan rate to compensate for risk and volatility.
Does tax benefit reduce effective loan cost?
Yes, if you are eligible for deductions, your effective interest cost may be lower than headline rate.
Is splitting between prepay and invest a good idea?
For many investors, a balanced approach reduces risk while still enabling compounding.