This article is based on a query we received on whether or not it is advisable to pay more than the EMI amount back every month on the home loan, so as to reduce the tenure of the loan and become free from debt faster. Let’s see how the case pans out.

Let’s call this person who wrote to us Mr. A.

Mr. A has taken a home loan of Rs. 10 lakhs from bank at the rate of 10.50% p.a. for 20 years on monthly reducing balance basis. His EMI is Rs. 9,984 but because he has surplus of Rs. 5,016 per month he can increase his EMI to Rs. 15,000. Now he has 2 options, either he can increase the EMI or invest surplus amount in combination of Equity Mutual Funds and Debt Mutual Funds on which he can get approx. 10% p.a.

Which option should he choose?

In order to decide whether to increase EMI or invest surplus amount, we have to do some number crunching…

Option 1 - Increasing EMI

If Mr. A decides to increase his EMI from Rs. 9,984 to Rs. 15,000, he will be able to pay off his loan in 101 months i.e. 8.42 years instead of 20 years.

In the remaining tenure i.e. 139 months amount of Rs. 15,000 can be invested at 10% p.a., it will give him Rs. 38,22,945.

Option 2 - Investing Surplus

If Mr. A decides to invest surplus of Rs. 5,016 p.m for 20 years at the rate of 10% p.a. he will get Rs. 36,31,517.

Note: We have not assumed any tax savings on interest paid for home loans.

Comparison:

 

Option	EMI	Loan Completed in period (Months)	Investment	Investment Rate	Tenure of Investment	Future Value of Investment
1	15,000	101	15,000	10.00%	139	3,822,945
2	9,984	240	5,016	10.00%	240	3,631,517
Excess value of investment by increasing EMI						191,428

 

• If we compare both the options we can analyse that in the 1st option loan is prepaid in just 101 months while it will take 240 months to pay off the loan if he doesn’t increase his EMI.
   
• Since the loan is paid in just 101 months in option 1, Rs. 15,000 can be invested for the remaining tenure of 139 months (240-101) at 10% p.a. which will give him Rs. 38,22,945 at maturity which is Rs. 1,91,428 more than option 2.




 

In such a scenario Mr. A is better off in Option 1 which is increasing EMI to Rs. 15,000.

But what if the rate of return on his investment changes?

Let’s assume investment rate of 12% p.a. instead of 10% p.a. (everything else remains the same)

Option	EMI	Loan Completed in period (Months)	Investment	Investment Rate	Tenure of Investment	Future Value of Investment
1	15,000	101	15,000	12.00%	139	4,334,677
2	9,984	240	5,016	12.00%	240	4,614,004
Excess value of investment by Investing Surplus						279,327

 

If we analyse it carefully we can see that just by changing the investment rate from 10% p.a. to 12% p.a. Mr. A’s decision regarding increasing EMI changed to investing the surplus amount because it is giving him higher maturity amount by Rs. 2,79,327.

Why did this happen?

In the 1st scenario his investment rate is less than his rate of interest being charged on the loan which means he is earning interest on investment at lesser rate while paying higher interest on his loans, so its better to increase EMI and pay off loan ASAP.

In the 2nd scenario his investment rate is more than rate of interest charged on the loan which means he is earning interest on investment at higher rate while paying lower interest on his loans, so its better to invest surplus amount.

By now you might feel that all the calculations involved here are too much complicated, but do not get carried away by this. All you need to do is remember 1 simple rule: If you can earn higher rate of return on investment than what you pay as interest on loan, it would be always be better to invest the surplus amount rather than paying higher EMI.

If you are still feeling confused you can always contact your financial planner to help you solve your query and if you don’t have financial planner you can contact us at info@personalfn.com

Add Comments

Comments
kelly@packaginglady.com Feb 25, 2012 Now a days banks are offering variable interest rates. First 5 years at one rate and after 5 years one rate and rest at one rate for a total tenure of 20 years. How do I calculate the EMI to compare with others who are offering fixed int emi
ltjain@yahoo.com Feb 29, 2012 A very educative article, though its in all our minds to increase our wealth and loan acts as a catalyst to fulfill this dream in today's economy. Thus, its essential to know the rate of loan and the rate of return on investment as suggested in the article. I will try to circulate it as much possible because its a subject worth giving time to. When we earn we value it, then why not study and then invest.  The calculation part is marginally erroneous because i had not been able to derive to the said amount despite trying manually and other available calculators for the same.  Thanks, in case possible, do reply with your formula to the email..
mitchell.levy@cxonetworking.com Oct 15, 2013 Now a days banks are offering variable interest rates. First 5 years at one rate and after 5 years one rate and rest at one rate for a total loan tenure of 20 years. How do I calculate the EMI to compare with others who are offering fixed int emi
seshanbalakrishnan@gmail.com Oct 22, 2013 One should take into account the post tax figures into account while comparing the options - more so cos the tax testament on housing loan is very much different against that of the investment in financial securities. Further, in financial securities itself (within debt - one may not want to invest in equity or equity oriented MFs asit has a different risk profile) we have differing tax treatments as in FD, FMP, debt mutual fund (growth option) etc. Also one should compute the Net Present Value (NPV) of differential cash flow of both options - to compare it on an apple to apple basis. The discounting factor to be used should be the post tax return one would get by investing in the financial security.
praveenunnikrishnan089@gmail.com Sep 20, 2018 Hi There, I got impressed by your article thank you for sharing this value with us. Also, There is an online Home Loan EMI Calculator which I use mostly for loan related calculations, and I want to recommend you too. Check Out This “Home Loan EMI Calculator” (Link is Mentioned Below) and you will find several home loan eligibility calculations online. Fingyan offers easy to use home loan EMI calculator that will help you know the actual amount of interest and EMI for the home loan you have taken. https://www.fingyan.com/home-loan-calculator/ Cheers, Praveen"

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