Home Loan vs. SIP Reader's Inquiry: If the anticipated return from my Mutual Fund SIP investment is 4% higher than my Home Loan Interest Rate, should I consider increasing my SIP contributions?
Welcome to the Reader's Query section of FE Money. Today, we have a question from Darshan Pawar, who took out a home loan of Rs 40 lakh in 2019. The outstanding balance on the loan is now Rs 25 lakh. Darshan also invests Rs 10,000 monthly in a Systematic Investment Plan (SIP) and holds Rs 14 lakh in the Employees Provident Fund (EPF) account.
Darshan is seeking advice on whether it's better to prepay his home loan or to increase his SIP contributions. He's also considering whether withdrawing money from his EPF account to repay the home loan would be beneficial.
Arun Kumar, VP and Head of Research at FundsIndia, offers guidance in response to Darshan's query.
If your expected return from your Mutual Fund SIP investment exceeds your Home Loan Interest Rate by 4% or more, then increasing the SIP amount can be a viable option. However, if this isn't the case, it's generally more advantageous to allocate the funds towards prepaying your debt.
The 4% buffer is meant to account for potential scenarios such as an increase in home loan interest rates or lower-than-expected returns on investments. For instance, if you assume a 12% return from your Equity SIP and your home loan carries an interest rate of 9.5%, it would make more financial sense to prioritize prepaying your home loan over increasing the SIP.
Furthermore, if the interest rate on your home loan is higher than the EPF rate, it may be a sound decision to use the EPF amount to prepay the home loan.
In a similar query addressed to another reader, Viplav Majumdar, a Certified Financial Planner and Director of Planyourworld Training Academy, suggested that increasing your SIP with surplus funds might yield more long-term benefits than completely repaying your home loan.
The key concept here is to generate returns on borrowed funds. If your home loan carries a 9% interest rate, and your mutual fund investments yield 12% in regular plans or 13.5% in Direct plans, you would be earning a significantly higher return compared to the interest paid on the home loan.
