Prepayment of home loans or investments ?

Question

I need your opinion as to whether I should make prepayments on my home loan or make investments for the same amount.

One thought says that my EMI amount will be fixed and considering a 20 year span, the worth of the EMI 10-15 years from now will be very less. The same amount can be invested in mutual funds having a medium risk.

My wife says that if we make a prepayment, our liability goes down and are done with the loan sooner as the prepayment amount is deducted from the principal amount and the floating rate of interest will go down in another 5-6 years to ~7% levels?

If anyone has already given thought to this, please reply. I'll really appreciate some thoughts from CAs and home loan professionals.

Answer 1

One of the best ways to calculate your return is to look at your ammortization schedule for your current loan. Many lenders have this available online or your can find a mortgage calculator which will print out an ammort schedule once you put in the ammount owed, interest rate, and minimum ammount due each month.

From there you can see by putting even an extra $25 dollars per month could jump you an extra month ahead or more ahead. Also look at your last statement from your mortgage company and see how much of your last payment was applied toward principal and how much was applied toward interest. If you're paying, for example, $600 a month, on a morgage payment and on average $28.09 is going to the principal then you're paying 571.91 in compound interest for that month. By doubleing your principal payment each month you can almost half the life of your loan. So we'll say for example purposes only with no ammort schedule for reference if you have a 30 yr loan (thats 360 months) and over the life of the loan you'll pay an average of $379 in interest that's $136440 in interest over the life of the loan with no accellerate payments. However if your made a double principal payment (not a full double payment) then that would effectively cut the loan term to 15 years (180 months) for $68220 in interest over the life of the loan.

This is a savings of 68220 for about $50 a month extra.

Take that in an investing scenario, the $50 x 15 years = 9000, so you would need 758% return on your money over those years compounded. (Risk has not been calculated for in either invetments or real estate)

Answer 2

Look at this way: you can make a guaranteed investment in your home at the interest rate listed on your mortgage. Or you make an investment in a mutual fund at "medium" risk.

Some questions about the mutual fund:
What is the 1, 5 and 10 yr average return of the mutual fund? What is the standard deviation of the 10 yr returns? What is the outlook for the next 20 years? If you are wise enough to sell the fund at the next market peak - and reinvest the funds in a lower risk invesment during the next downturn - will your return exceed your mortgage interest rate? Finally, is the mutual fund a tax-efficient fund, or does it have a high turnover, generating a lot of short-term taxable gains? What is the front-end load, 10(b) charge and annual expense ratio?

If the outlook for the fund is significantly better than your mortgage after considering those factors, then buy the mutual fund. If not, then your house is a better investment unless you are living in an area with poor housing appreciation and/or job growth prospects.

One consideration for investing in a mutual fund is the diversification that it offers to your portfolio, compared to only investing in your home. That may be an advantage.

Note that this doesn't have to be an either-or scenario. You can always invest a portion, say 50:50, of your investment funds into both paying down your house and investing in mutual funds.

Answer 3

I have a question for you. Will you really invest the money or will it gradually disappear like change in your pocket. My advice is to pay down the principal on loans with the highest interest. If your home has the highest interest,pay on it. If its credit cards, pay those. The stock market is risky. Paying down your mortgage is guaranteed return. You can pay of your home off much sooner and get the peace of mind that owning your home brings. Thats worth losing the little extra you might earn on another investment. When you sell your home it will be at a lower tax bracket. It might even be a tax free sale. That eliminates any difference in investment return.

Answer 4

I took a 30 year loan down to 12 years by paying more on the principal each month, usually about $50-$100. I never calculated how much I saved in interest payments, but I'm sure it was substantial.

I also liked the fact that the house was paid off and no one could take it from me.

Answer 5

You will save a whole lot of money if you start part - prepayment. During initial year, max around 10% of EMI only will be adjusted towards your principal, remaining goes to only interest. I will show you a simple calculation based on my experience. Say you have taken 10 Lakhs loan at 10.5 % interest, for duration of 10 yrs. This results in EMI of Rs.13494. With this, the total interest you would pay is -Rs 6,19,176. and the terms would be 120 months. Say you do a partprepayment of 1 L at the 6th month of first year, Lets see how this looks: The total interest goes down to Rs 4,69,335. Just by paying 1 L at the 6th month saves you close to 1.5 L. (total number of terms becomes 102 instead of 120) Say each year you manage to do additional payment of 1 L at the 6th month of every year [Last one year you cannot do any part prepayment - because you need to leave last one year amount untouched to avoid any penalty] With this you would be paying 1L each on Feb of 2010, 2011, 2012 & 2013. The total interest would be - Rs 2,88,601 (more than 50% savings) and total number of months - 66 (50% reduced) If you pay 50 K once a year - from 2010 - 2015, then total interestis Rs.3,86,074 [35% savings ] and months would be 86. So try to save some additional amount at the initial period itself and do a prepayment - check your banks terms on number of times you can do a part-prepayment (leaving one year EMI) (Hope your loan is on monthly rest) Hope this helps.

Answer 6

If you don't have much in the way of stocks or mutual funds I would start investing extra money there just for the diversification. You wouldn't want all your wealth tied to your home. If you already have existing funds then you could put money into both.

Answer 7

If you haven't already, read the book Richdad Poordad, by Robert T Kiyosaki.

Answer 8

Once in awhile you should learn to abide by your wife's' opinion.She is right in this case.Repay your loans

Answer 9

make prepayment .it is safe.