Prepay Loan or Start Investing; What is Rightful to do?
Investment and Loan – both terms are essential as a part of a human lifestyle. Investment in various kinds at an early stage will help in securing the future and provide financial stability. While taking a Loan for some purpose, like a Home Loan for buying a home or an Education Loan for higher studies in a domestic or foreign country, may fulfill the needs of a middle-class person at times but puts a huge burden on the pocket.
So, it is necessary to understand the aspects of both of them. Let’s understand by an example or case, how investment and prepaying loans can be done simultaneously.
Example: Amit Sharma was an MBA student; after completing the MBA from an institute, he bagged a job in a retail multinational company. He wants to fulfil his dreams and improve his standard of living, but he gets trapped by a Rs. 25 lakh education loan as he is required to pay the loan over 10 years. He also received a joining bonus of Rs. 4.5 lakh. Someone advised him that the 20s are the best time to start investing and he wanted to invest the amount. However, he got confused and hanged between the two: should he start saving for his future or use the fund to prepay his education loan?
Amit needs to keep on track with the payments of his education loan; he needs to ensure that he pays at least the monthly due amount to maintain a good credit score for securing future loan eligibility. Automating the payments on an EMI basis and considering them as a fixed expense will help him stay consistent.
He should also consider setting up an emergency fund, which may act as a backup of EMI payments in case he loses his job in the near future due to unexpected reasons. If he doesn’t have an emergency fund, he can consider allocating the Rs. 4.5 lakh bonus to set up the emergency fund.
After setting up the emergency fund, he can now consider prepaying the education loan. He should begin by considering the lender’s prepayment terms, particularly if there are any penalties.
Under the old tax regime, it is essential to keep in mind that the interest paid on an education loan is applicable for a tax deduction under Section 80E of the Income Tax Act. A benefit he would forfeit by opting for prepayment.
If the calculations favour that loan prepayment sounds beneficial, he should use this as an opportunity to lower his debt.
He will be better equipped to handle his future financial challenges by decreasing his debt now and adopting healthy saving and investing habits.
