How to use your Bonus: Invest in Equity Mutual Funds or Prepay Home Loan: The month of April is the time for many employees to receive their annual bonus for the last financial year. If the appraisal is good then there is hope of good bonus and salary hike. But along with the happiness of having more money in hand, sometimes there is also confusion as to how to use this money properly? Would it be better to repay your home loan early or invest this money in equity mutual funds? If you have also received extra income due to bonus, salary increase or any other reason, then this confusion may also arise in your mind.
Consider the advantages and disadvantages of both options
Before deciding between pre-paying your home loan and choosing one option for mutual fund investment, it is important to consider the positive and negative aspects of both the options. For this, you will have to compare the interest rate of home loan and the possible annual return of mutual fund and also see the difference in your tax liability in both the situations. Apart from this, you will also have to consider your financial goals, risk appetite and liquidity position. Only then will you be able to take the right decision in this regard. Here we will consider all these aspects one by one.
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Home loan interest rate vs mutual fund returns
Before deciding where to use your extra funds or salary, you need to look at the interest rate on your home loan and the average returns you can expect from investing in mutual funds. If your home loan interest rate is between 8.50 percent to 9.50 percent and you are expecting to earn an average return of 12 percent per annum from equity mutual funds, then obviously you will find it better to invest in mutual funds. Because the average return you will get on investing in equity funds is 2.5 percent more than the interest on home loan. Generally you will find that the long term returns of equity funds are higher than the interest rates of home loans. Besides, investing in equity funds through SIP also gives the benefit of compounding and averaging. That is, if seen only from the point of view of return and growth, then investing in equity mutual funds will appear to be a better option. But the final decision cannot be taken on this basis alone. For this it is also important to consider some other important things.
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impact on tax liability
You also need to see what effect both options may have on your tax liability. This is because on paying home loan interest, you get an additional deduction of up to Rs 2 lakh per year under Section 24B. Apart from this, tax exemption is also available under section 80C on re-payment of principal amount. By the way, under Section 80C, you can also avail the benefit of tax exemption on investments made in equity mutual funds on investments up to Rs 1.5 lakh annually. But under Section 24B, the benefit of deduction up to Rs 2 lakh is available only on home loan interest. This means that if you repay your home loan early, then you will not be able to get this benefit, which may increase your tax liability. However, if you invest in equity mutual funds for 3 years, there is no tax on profits up to Rs 1 lakh per year and on profits above that, only 10 percent Long Term Capital Gains (LTCG) tax has to be paid, which is tax saving. It is a very good option from this point of view.
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impact on liquidity
Before deciding to repay the home loan early, you will also have to see what your liquidity position is. That is, how much do you need that additional fund or earning or may you need it in the near future. If you spend the bonus funds to repay the home loan, you cannot take them back, whereas investments made in equity mutual funds can be withdrawn as and when required.
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risk appetite
There is no risk on your investment in case of early repayment of home loan. That amount is directly deducted from your home loan. Also, if you are paying 8.50 percent annual interest on your home loan, then whatever amount you pay to repay it early, 8.50 percent return can also be considered assured. At the same time, you can expect a possible return of 12 percent on equity mutual funds, but there is no guarantee. Therefore, before investing in mutual funds, it is important to assess your risk profile i.e. your ability to take risk.
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investment goal
Whether it would be better for you to pre-pay home loan or invest in mutual funds, it also depends on your investment goal. If you want to build your retirement corpus through regular investments over the long term or want to fund your children’s education, then mutual fund investment can be a good option for you. But if you do not have much time left in your retirement or you are not in a position to make regular investments for a long time for better returns, then it would be better for you to repay the home loan early.