Q: Should I repay a loan first or invest the fund? – Shankara
A: The decision to repay a loan first or to invest the fund depends on the rate of interest applicable on your loan and your expected return if you invest it. So, you have the following options in hand:
- If the interest on loan > expected return on investment: Consider repaying your loan first
- If the interest on loan < expected return on investment: Consider investing for an attractive return
While taking such a decision you should also consider the impact on tax obligation. Let’s suppose you have some surplus fund in hand and you have to decide between repayment of the home loan amount and investment in a mutual fund equity scheme. If you have not exhausted the 80(C) benefit against payment of loan principal, then by repaying the extra amount you can increase the tax benefit to that extent. So, compare the ROI after tax with the interest saved by repaying the loan early, to ascertain which is more beneficial. Also, check the type of loan before you repay it early because it may be subject to a prepayment penalty in some cases (like a personal loan).
Before investing the surplus fund also check the risk involved in such an investment. If the risk is very high, then it’s better to repay the loan amount first. Before early repayment of the loan, you’ll be well-advised to check its impact on your credit score too.
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