Loan prepayment involves paying more than the outstanding payment amount to reduce both principal and interest amounts. According to the analysis, this strategy allows borrowers to become debt-free earlier than their scheduled repayment period. The primary benefit is the immediate reduction in interest burden, making it particularly attractive when loan interest rates are high. However, prepayment may not be suitable for everyone, as it requires surplus funds and may not be optimal for those seeking long-term wealth creation through market investments. Mayank Prakash, Co-Founder & Director of aarthiq, emphasizes that paying off debt could be the better option when borrowing costs are relatively high, particularly for loans carrying interest rates of around 13-14 per cent, such as some personal loans.
For borrowers with low loan interest rates, investing surplus funds in market-linked schemes presents another option. As reported, this approach can create a corpus for future requirements such as retirement planning, asset purchases, or children's education. The analysis highlights that long-term investment can benefit from compounding effects, potentially generating higher returns over time. However, market-linked investments carry inherent risks and are not guaranteed to provide returns, making them unsuitable for those with very low risk appetite. Mayank Prakash notes that comparing loan interest rates with expected post-tax investment returns is more meaningful than relying on headline numbers alone. For instance, a home loan carrying an interest rate of around 8-8.5 per cent may be compared with long-term equity investments that have historically delivered returns in the 11-12 per cent range, but after factoring in Long Term Capital Gains (LTCG) tax, the effective return could work out closer to 10-10.5 per cent.
The analysis provides a practical example using ₹6 lakh surplus funds. In the loan prepayment scenario, this amount can save interest equivalent to the loan rate over the remaining tenure. Alternatively, investing the same amount in mutual funds for a long period may generate higher returns, though market-linked returns are not guaranteed. This comparison illustrates the trade-off between immediate debt reduction and potential long-term wealth creation through investment. Mayank Prakash cites an example of someone with a home loan of around 8 per cent and monthly surplus, where continuing a Systematic Investment Plan (SIP) for around 15 years could potentially grow into a noticeably larger corpus than the amount saved through prepayment over the same period, based on long-term market trends.
The choice between loan prepayment and investment depends on several key factors including loan interest rates, risk appetite, retirement timeline, and financial goals. According to the analysis, individuals with high loan interest rates, very low risk appetite, approaching retirement, or seeking to decrease financial burden should consider prepayment. Conversely, those with more time, comparatively low loan interest rates, risk appetite, and seeking long-term wealth creation without guaranteed returns may benefit from investment strategies. Mayank Prakash recommends asking critical questions before deciding: is there an emergency fund already in place, how does the loan's interest rate compare with expected post-tax investment returns, does the loan offer any tax benefits, and is your income reasonably stable in the near term? The report emphasizes that a balanced approach combining both strategies can help achieve comprehensive financial goals, with experts noting that age, financial goals, emergency savings, and personal risk appetite are equally important factors in the decision-making process.
