Should you pay off your home loan before investing for retirement?
Only high-cost debts such as credit card balances and personal loans must be paid off immediately. Low-interest loans can be repaid gradually.
February 17, 2022 / 09:41 AM IST
Should you clear off all the loans first and then think about retirement planning? Or should you address both loans and retirement savings together?
There are strong supporters on both sides. And to be fair, neither side is wrong here. Clearing off all loans (especially large ones such as home loans) does give a good feeling and mental peace. And these cannot be justified with money or mathematics of loan repayment.
But are loans bad and should they be repaid as soon as one can?
I don’t think so. High-interest loans such as credit card debt, personal loans, etc. are of course bad for financial health and you should pay them off quickly. But home loans aren’t that bad to continue with.
Why I am saying this is because let’s say you are 30 and decide to take a home loan for a 25-year tenure. Now, if instead of investing for retirement, you use extra funds to regularly prepay the loan and clear off the home loan in 15 years, you will definitely feel proud of yourself.
But does it really make sense given that the post-tax home loan rates are so low? No, it doesn’t make a lot of sense. And that is because if you were investing that money, you would not have missed out on a lot of compounding during the 15 years.
Your provident fund will not be enough for your retirement needs. You need to invest more. Plain and simple.
How to decide between paying off loans vs savings
Here are a few pointers to get you going (assuming you have multiple loans):
Note - Mathematically, it's much better to make prepayments during the initial years of the loan when the outstanding principal is still high. Here’s why.
- Continue paying regular EMIs for all your loans: home loans, personal loans, car loans, etc.
- Make sure you have proper health and life insurance.
- Then ensure that you have a big enough emergency fund in place. Not a large one, but one which gives you some buffer for the unexpected and uninsured curveballs that life might throw at you.
- If you do not have any investible surplus left after all this, then you are currently living pay-cheque to pay-cheque. A risky way to live. Think hard about this and acknowledge that it’s time to pull up your socks.
- If you have surplus leftover, then start clearing off your credit card outstanding quickly.
- Once credit cards are clear, begin clearing off your personal loan (if high-cost loan).
- All this while, continue paying your regular home loan EMIs.
- Next, do some number crunching (or ask an investment advisor to do it for you) to figure out how much you need to invest for each goal like retirement, children’s education, etc.
- Let’s say the financial planning calculations tell you that you need to invest Rs 20,000 per month for your children’s future and Rs 25,000 per month for your retirement. Let’s say you also have a Rs 45,000 monthly surplus leftover after all expenses and EMIs. Here is what you should do.
- Start investing the full required amount of Rs 20,000 per month for children’s education.
- For retirement, you can start investing a smaller amount than what is required (Rs 25,000 per month). Why? Because you are already investing some via automatic contributions to EPF, NPS, etc. So let’s say, you start with Rs 15,000-20,000 per month towards retirement.
- That way, about Rs 5,000-10,000 would still be left with you. This surplus amount, you can use to begin prepaying your home loan as well if you want to accelerate home loan prepayment. If you don’t want to do that, then increase your retirement investment contributions simply.
- Apart from all the above, you can even consider making additional ad-hoc payments to home loan using your incentives or annual bonuses.
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