Summary
When you have surplus cash, should you prepay your home loan or invest in mutual fund SIPs? The answer depends on your loan interest rate, expected investment returns, tax bracket, and risk tolerance. This calculator compares both scenarios over the remaining loan tenure to show which approach builds more wealth.
How it works
Prepayment benefit
Prepaying your home loan reduces the principal, which saves interest for the remaining tenure. The benefit is:
Interest saved = Total interest without prepayment - Total interest with prepayment
This is a guaranteed, risk-free return equal to your loan interest rate (effectively 6.5-9% depending on your loan).
SIP benefit
Investing the same amount in equity mutual fund SIPs aims for higher returns (12-15% historically for equity) but carries market risk. The SIP accumulates through compounding:
SIP corpus = Monthly amount x [((1 + r)^n - 1) / r] x (1 + r)
Tax considerations
- Home loan interest deduction under Section 24 (up to Rs 2 lakh for self-occupied) reduces the effective cost of the loan
- LTCG on equity above Rs 1.25 lakh is taxed at 12.5%
- If you are claiming Section 24, the effective loan rate is lower, making SIP more attractive
Decision framework
| Scenario | Better option |
|---|---|
| Loan rate > Expected SIP return (post-tax) | Prepay |
| Loan rate < Expected SIP return (post-tax) | SIP |
| Risk-averse, close to retirement | Prepay |
| Young, high risk tolerance | SIP |
| Already maxing Section 24 benefit | Either (depends on rate) |
Worked example
Loan: Rs 40 lakh at 8.5%, 15 years remaining. Surplus: Rs 25,000/month
Prepayment scenario:
- Extra Rs 25,000/month reduces tenure from 15 to ~8.5 years
- Interest saved: approximately Rs 15,00,000
- Guaranteed effective return: 8.5%
SIP scenario (12% expected return):
- Rs 25,000/month SIP for 15 years at 12%
- Corpus: approximately Rs 1,25,00,000
- After LTCG tax: approximately Rs 1,17,00,000
- But you also pay full loan interest: Rs 30,00,000
- Net wealth: Rs 1,17,00,000 - Rs 30,00,000 = Rs 87,00,000
The SIP scenario builds more wealth if returns materialize at 12%, but carries market risk. Prepayment guarantees the 8.5% return.
Inputs explained
- Outstanding loan — remaining principal balance
- Loan interest rate — current rate
- Remaining tenure — years left on the loan
- Monthly surplus — amount available for prepayment or SIP
- Expected SIP return — assumed annual return on equity investments
Outputs explained
- Interest saved (prepayment) — guaranteed saving from faster loan closure
- SIP corpus — projected mutual fund value
- Net wealth comparison — total financial position under each scenario
- Break-even return — the SIP return needed to match prepayment benefit
Assumptions & limitations
- SIP returns are not guaranteed. Equity markets can underperform for extended periods.
- Does not model partial prepayment with partial SIP (splitting the surplus), which is often the optimal practical approach.
- Section 24 tax benefit is capped at Rs 2 lakh for self-occupied property. If you prepay and total interest falls below Rs 2 lakh, you lose some tax benefit.
- Home loan prepayment has no penalty for floating rate loans in India (RBI regulation).
Sources
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