This dilemma of paying off the loans or investing and saving for retirement has been a major cause of concern for the strata of people who are salaried in the economy. The salaried individual will avail of a loan and select an EMI that he can comfortably pay from his earnings. The individual will then in the future face the dilemma of either paying off their debt first or investing for their retirement and accumulation of savings. The individuals will in the event of time increase their capacity to earn and thus they feel that their debts can be paid off before time. The extra cash or surplus that accumulated due to the increase in income is the reason for this dilemma.
If you were to ask a financial planner if the debts are to be paid first or the money has to be saved for investments, the financial planner will almost always suggest that the debts are to be paid first and the investments are to be done later. This is because the thumb rule of personal finance states that your debts are to be paid first and the savings are to be done later.
The reason why people will always select to save some money is also human psychology. Human psychology will suggest that there should be some money left with you even if your savings are earning more or less the same money that you are paying for your debt.
The early prizes and benefits of paying off your debt are more than saving. For example, if you pay Rs. 10,000 extra per month you can save the interest of approximately Rs. 12lakhs per year. Thus you can see that paying your home loan early will straight away reduce the loan outstanding amount and thus reduce the debt burden.
Paying your debts early will have an advantage as the burden is quite a lot to handle. If you consider as per the above example that you save on interest of Rs. 12 lakhs per year, you will be incurring a tax loss of Rs. 2.4 lakhs so you have earned an income of net Rs. 9.6 lakhs. If on the other hand, you choose to invest these 12 lakh rupees in the market you can earn a return on average of 12% per year which yields to Rs. 26.4 lakhs. But you can never be sure about the earnings in the market as they are subject to risk and may fluctuate. Thus you can never take your retirement savings for granted.
For saving your money for retirement, you can diversify your accumulated corpus into debt, small saving schemes and equities. To begin with, you can park Rs. 8-10 lakhs as a contingency fund and keep it liquid in any savings account or fixed deposit. You should keep this as an emergency fund and not use this fund unless in case of any dire emergency. You can invest the remaining funds in buckets of debt, low duration debt, medium duration debt and equity. This concept of keeping your savings in buckets will help you keep your savings intact and not exhaust all buckets of savings at once. The aim of these retirement savings is that they should cover the cost of inflation and still be able to give you some surplus to spend every month. The equity and debt oriented investments can grow a lot in this period which is around an individual’s whole duration of the service period approximately 20 years. Any immediate needs can be taken care of by the liquid funds and low duration debt funds.
There are some products that provide overdraft facilities and help you in case of any emergency. All you have to do is park some surplus money into these products and not worry if they are used as prepayment. It is more like an option of prepayment with the option of taking out that money in case of any contingency. You can strategize the investments by keeping the home loan interest near to Rs. 2lakhs per annum with these products. In case you use this for savings or investment purposes, SIPs can also go from these products.
The next deciding factor for this question is the tax benefit that you derive every year. You can claim a deduction for the principal portion under Section 80C and the interest of the loan under Section 24 of the Income Tax Act, 1961. The deduction of house loans with respect to the self-occupied property is limited to Rs 2 lakhs per annum for the interest component.
You can conclude that it is more of a mind game than a numbers game for this question to be answered. So, you need not always choose between the two; you can allocate your surpluses for prepayment till they are tax effective and the rest of the surplus to investments for retirement.
FAQS Should you pay off your home loan before investing for retirement?
1:Is deduction available under Section 80C for house loans?
The deduction is available under Section 80C for the principal part of the house loan.
2:Is the tax benefit worth the prepayment money?
If you assess, the answer depends on case to case basis. In general, mostly you will find that prepayment will not be the preferred option.
3:Should debt be paid before retirement?
Yes, your savings might not be able to cover the inflation cost and the monthly installments required for paying off your debts.