Holding a debt is an unwanted and distressing thought for many individuals. Even if they are comfortable paying the EMIs, they certainly aren’t at peace mentally. If you feel as if the sword of Damocles is hanging over your head, then just pay. In such case, you should repay your loan provided you have built an emergency fund, and you have no other high interest loans like a Credit card or Personal Loans.
In today’s uncertain job market, a lay-off can lead to several months of unemployment. A serious illness or disability due to illness or accident can also hamper one’s ability to earn for a prolonged period. When life throws nasty financial surprises your way, have a Plan B ready. An adequate emergency fund can help you tide over the crisis.
Many use credit cards to tide over the emergency till you are able to arrange funds. But credit cards should not be seen as a replacement for setting up an emergency fund.
Emergency Funds are to help you deal with the unexpected. An emergency fund is typically around 3-6 months of living expenses. This thumb rule varies according to individual circumstances. If you have health insurance, you won’t need a contingency fund during a medical emergency. If it is cashless, you may not have to shell out even a rupee if you don’t have an emergency fund then before prepaying the home loan it should take priority.
You should consider the post-tax return. For those in the 30% tax slab, and with outstanding home loan balance less than Rs 20 lakh, the effective cost of a loan is only 6.65% So you can invest in options which will generate higher returns.
For example, PPF, Sukanya Samruddhi Yojana and listed tax-free bonds, offer higher annualised return than 6.65
If your time horizon is longer and you can take risk, then you can consider investing in equities, either through mutual funds or directly which can generate better returns
the annual interest amount is more than 2 lakh rupees, then by prepaying the loan you save on future interest payment. For example, the annual interest on a Rs 70 lakh outstanding loan, at 9.5%, comes out to be Rs 6.65 lakh. After considering 2 lakh rupees deduction under Section 24C, the interest amount will fall to Rs 4.65 lakh, so effective cost of interest will reduce from 9.5% to 8.64%, for those in the 30% tax bracket.