Home Loan EMI vs SIP in mutual funds (2023)

Home Loan EMI Vs Mutual Fund SIP is one of the many dilemmas that home loan borrowers face. They think where using MF SIP to prepay home loan makes sense or not.

There are others dilemmas too. Some questions that you wish you had clear answers for. For example:

• How much loan can I get? And how much loan should I take?
• What should be my home loan EMI? What are the benefits of going for a higher or a lower EMI?
• What is the ideal home loan tenure? Should I take a loan for long tenure or for a short one?
• Does prepayment of home loan make sense? If yes, how often or how rarely should I prepay?

But as with all things in personal finance, there are no one-size-fits-all answers here too in our discussion of Loan EMI vs SIP. Obviously, each case is unique and there will be several permutations and combinations. So each case requires individual analysis and decision-making.

And the home loan is mostly unavoidable these days. It’s a necessary evil that must be embraced due to the sky-high property prices.

In this post, I wanted to address a dilemma that many people taking home loans have about prepaying home loan or invest in mutual funds.

Conventional wisdom says that it is always good to get rid of any kind of loan as soon as possible. But we know that home loans are different. It is one of the cheapest loans available and if you include the home loan tax benefits, the effective cost of the loan reduces further.

So many people have this question in mind:

Should I take a home loan of long tenure + lower EMI and invest the surplus?

Or

I should take a home loan of shorter tenure + higher EMI?

And this question becomes more bothering after the loan is taken. That’s because, at the time of taking the loan, most people stretch themselves to service their loan EMIs. But as their income grows, they have a surplus left that can either be used to start making prepayment or to invest elsewhere.

To be honest, this is a regular question of invest vs prepay. So the idea obviously is that if there is a possibility of finding an investment option that offers better returns than the cost of your home loan, then whether you should invest or you should start prepaying. And it goes without saying that when we are trying to invest for ‘higher’ returns, then the returns on investments are not guaranteed. That should be kept in mind when deciding.

So does investing in mutual funds while paying Home Loan EMIs make sense?

Let’s try to find out.

Combination of Home Loan EMI and Mutual Fund SIP

People will try to claim that this is a method to ‘How to get Home Loan at 0% Interest Rate in India?’ or maybe ‘strategy to pay zero interest on home loan’ and what not… But let’s not get too excited and ahead of ourselves. I think it’s just about the optimization of the available surplus at hand.

So what is it that we are comparing and what scenarios?

You are planning to buy a house for which you wish to take a home loan of Rs 40 lakh. Now you have 2 options:

• Go for 15-year tenure and higher EMI
• Go for 25-year tenure and lower EMI and invest the surplus in equity funds

There are 2 schools of thought here:

• Go for the shorter tenure and get rid of the loan as soon as possible. Plain and simple.
• If the home loans are so cheap, why should somebody try to pay (prepay) the home loan quickly? Better to let the home loan running for long and invest the surplus elsewhere in equity mutual funds via SIP for higher returns.

Now both approaches are good for a different set of people.

I have seen borrowers worried about home loans and they just want to get rid of them as soon as possible. They want to prepay as frequently as possible to aggressively reduce the outstanding loan. And I can tell you that many are very very aggressive about this approach.

I have also seen those who know their maths and have tons of patience. These people opt for longest-tenure home loans and reduce their EMIs to a bare minimum. And then invest the money saved (when compared to shorter tenure loan EMIs) aggressively in equity funds. They know the Loan EMI vs SIP in mutual fund logic and move accordingly.

Let’s run some numbers and see it now:

Loan EMI vs SIP in mutual funds

Can mutual fund SIP help you repay your home loan quickly?

Let me repeat the scenario here:

You are taking a home loan of Rs 40 lakh at 7.5%. You have 2 options:

• Opt for 15-year tenure and EMI of Rs 37,080
• Opt for 25-year tenure and EMI of Rs 29,560 and invest Rs 7520 (surplus) in equity funds at 10-12% returns.

You can use this Home Loan EMI Calculator to find out home loan EMIs.

Please note that the return assumed on investments in the above calculation is not guaranteed but we can safely assume that SIP in equity funds will deliver 10-12% average returns over the period in consideration.

Before we proceed, let’s have a look at the simple amortization schedules of both loans.

First is the 15-year home loan:

As you can see, on a loan of Rs 40 lakh, the total interest outgo is Rs 26.7 lakh over 15 years.

Now compare this with a 25-year loan:

On the same loan of Rs 40 lakh but for a longer tenure of 25 years, the total interest outgo is Rs 48.7 lakh!

This clearly tells one thing: Shorter the home loan tenure, lower the total interest paid. I have already written about it at How you can save lakhs by taking a Shorter Loan Tenure. You can read it to know the details.

But these were simple comparisons of different loan tenures.

Now we need to compare different loan tenures but with the same monthly outgoes

Than is…

• Case 1: 15-year loan (EMI Rs 37,080). Total Outflow = Rs 37,080
• Case 2: 25-year loan (EMI Rs 29,560) + SIP (Rs 7520). Total Outflow = Rs 37,080

Do note that you are fully capable of having a monthly outgo of Rs 37,080 in both cases.

The only difference is whether it will go in form of pure loan EMI (in 1^st case) or as a combination of EMI+SIP (in 2^nd case).

Now let’s see what happens exactly in the 2^nd case. Here is what happens:

• You take the loan of Rs 40 lakh for 25 years.
• You begin paying a monthly EMI of Rs 29,560.
• You also start a monthly SIP of Rs 7520 in equity mutual fund

What happens next?

If we assume 11% CAGR on SIP investments, then the value of Rs 7520 per month SIP would be about Rs 30.1 lakh at the end of the 14th year. This is higher than the outstanding loan of Rs 26.5 lakh at the end of the 14th year.

So we can say that sometime during the 14th year of the loan, the outstanding loan principal amount would be equal to the fund value of the SIP.

Here is the scenario in table form:

So that’s a kind of home loan vs SIP calculator or home loan prepayment vs investment calculator that you can use.

And in the SIP Vs EMI calculator above, if you compare this with the 15-year loan, then you can theoretically close the loan in the 14th year instead of the 15th year.

And if you get higher than 11% average returns, then the loan can be closed even earlier. But since the whole concept of this discussion is built on the difference in the rate of home loan and expected returns from investments, there are can be several other scenarios. Like if returns are less than 11% and home loan rates (floating) increase to something more than 7.5% which was originally considered.

Ofcourse there is also this tax-saving angle that should be considered when deciding between prepaying a home loan or investing in mutual funds.

You get a Rs 1.5 lakh deduction for principal repayment under Section 80C. But I am assuming that this Rs 1.5 lakh deduction will already be used up by other options like EPF, ELSS, PPF, School fees, etc. So the focus should instead be on the exclusive Rs 2 lakh deduction available for home loan interest payment via Section 24.

Nevertheless, it does seem that if the difference in loan rate and expected equity returns is reasonably large; and actual returns delivered are equal and more than the expected returns, then doing the SIP of the surplus amount is beneficial and helps your case.

And ofcourse there are other benefits like having a growing corpus of funds that can be used any day to reduce the outstanding loan amount if interest rates are hiked or if other factors change in unfavorable ways.

Investing in Mutual Funds while paying Home Loan EMIs can have various other forms of cost-benefit analysis. I can easily use more data to prove that how mutual fund SIP can help you repay your home loan quickly.

But I would like to repeat as this is important. This is not a foolproof way (with any guarantee) of closing the loan quickly. But no doubt, it seems like a reasonably decent strategy with a high enough probability of success. That is assuming that you are willing to keep the loan sword hanging if need be and if market returns are not great temporarily.

Everyone has a different view on this.

But remember this – a home loan is not your only priority. You need to ensure that you start saving for other financial goals in time so that you aren’t late and at the mercy of luck to achieve your goals.

There can always be a more common-sense strategy that can be followed instead of just focusing on the home loan.

Let me try and list down what I feel should be done:

Strategy to Manage Home Loan, its Prepayment & Other Financial Goals

This is not a perfect strategy. But it tries to give importance to various things:

• Take a home loan of 20-25 years.
• Start paying the regular EMI
• Find out how much you need to save for other important goals like retirement and children’s education.
• Start saving monthly for retirement and/or start saving monthly for children’s education.
• If you have any surplus left, start investing that monthly in equity funds and tag it as ‘Home Loan Prepayment Fund’
• If the equity returns in 1-3 years are great and your loan-repayment corpus grows suddenly to an unexpected amount, take some money out and part-prepay your home loan.
• If the floating home loan rate rises too much, then take some money out and part-prepay your home loan.
• But continue your SIP in ‘Home Loan Prepayment Fund’.
• You can even consider using a part of your annual bonus to prepay a part of your home loan every year. It is your call.
• Once the loan-closure-fund value becomes more than the outstanding home loan amount, you have the option to close the loan in one shot and be done with it. That’s your call then.
• If possible, do give cognizance to the interest rate and equity market scenario to take a situationally aware decision then.

This is not a perfect strategy.

But just something that can be considered if it fits in your unique situations. After all, any strategy whether it’s Loan EMI vs SIP or goal-based investing should help you get what you want. That’s all there is in personal finance.

I have also heard about other different strategies like “Start 1% of home loan as SIP”. So one can have many different approaches to solving this problem.

You may really wish to aggressively repay your home loan. This no doubt has an emotionally satisfying feeling to it. But since the home loan costs are low, you are also in a situation where you can consider other goals as well.

You don’t want to compromise your other financial goals just because you wanted to close your home loan early.

Isn’t it?

Further Reading – Best time to prepay home loan

And please, do not forget to have a term life insurance cover that is always larger than what your outstanding loan amount is. Better still, find out how much life insurance you need and then buy it as soon as possible.

To conclude, there is not much left to say about using SIP to prepay home loans.

Just know that it’s difficult to make a decision when multiple options are available. In such situations, do not try to make the perfect decision. Just spend some time thinking about it and exploring with the above-mentioned Home loan vs SIP calculator; take advice if need be, and then make a reasonable decision

There is no size fits all approach in investing or financial planning. Just because your friend is gung-ho about closing his home loan does not mean that you too should do it.

Do not get too obsessed with the repayment of your home loan. It is important but not too important. There are other goals to take care of as well.

In your deep thoughts about Loan EMI vs SIP And planning to use MF SIP to prepay a home loan, don’t forget about other goals.

If you still feel that early or smart home loan closure is necessary, then we have already delved deeply into the home loan EMI vs SIP 2023 in equity fund discussion. You know that in certain cases, investing the surplus in mutual fund SIP instead of prepaying can actually help you repay your home loan quickly.