Perennial dilemma
This is a common problem. Almost every salaried person who borrows a home loan may face this problem at one time or another. You get a loan with an EMI that you can afford. Your income grows, and you can repay more of the loan. This is a PERENNIAL QUESTION. Here is an example. A customer has a home loan and is paying an interest of 7.50% per year. He can pay the EMI easily from his salary. the borrower now realizes that he has cash left over, which he can use to invest. He wants to know which option was better: Pay off some of his outstanding home loan amounts on time or invest in an equity mutual fund over the long term.
A financial planner would likely tell you that you should repay the loan first if you ask him this question. This advice is the basis of the first principle of personal financial planning: clear your debts before saving.
This principle is sound and should be applied almost every day.
To save or clear debts?
If one had to choose between saving or clearing credit card debt/personal loans, It is best to save. This principle is likely to apply to most consumer loans, even those expensive, like automobiles. People who borrow or invest are most likely to be affected by this principle.
There are some caveats to this standard advice. It seems that long-term equity mutual funds investments will likely yield higher returns than housing loan savers. SIP returns have historically been higher over the ten years. It is true for anyone who is trying to save money while paying off a mortgage.
The tax benefits one receives on interest paid are a better deal for a housing loan. Calculating the actual effective interest rate will show you that you have even greater savings if you account for this. You no longer need to rent if you take out a loan. That is the real benefit. Only when someone has a sufficient amount of financial savings that is both liquid and easily accessible and where there is no significant expense anticipated can it be justified to pay off the loan.
Savings is the finest option
Human psychology is another aspect of this. A person who has very little savings or none would prefer to have the loan and still have savings. It would be sensible to have savings available if you need them, even if they fetch less or the same returns as the debt. Savings played an important part in the COVID-19 pandemic of 2020.
The rules for emergency money are different. Any disadvantage caused by an interest rate differential is worth having instant access to an emergency fund.
