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Loan Repay Or Invest In Mutual Fund, Take An Informed Decision
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This is a very common question asked by most of us who are having some or other loan and have some lump-sum money either to repay the loan partly or to invest in Mutual Fund. This lump-sum money might have come from yearly bonus or through maturity of certain existing assets.
Though there is a mathematical aspect of this (to repay or to invest) which can tell us how much interest you are going to save vis-à-vis possibility of wealth creation - there is another aspect of this which is built on common sense and thumb rule. Let us look at that side.
Ask these three questions to yourself, get the answers and act accordingly:
What percentage of monthly income goes towards paying EMI? If EMI is >=40% of monthly income then there is a serious reason to worry about. Is this loan outgo every month creating a stress on you?
If your answer is YES to the above questions - then forget everything and start repaying the loan with available resources till the time it becomes bearable or manageable. Also having an emergency fund of amount 3 – 4 times of all monthly expenses put together is a necessary for all of us – more so when we have EMIs to pay.
Is my making part payment towards loan going to affect some critical financial goal of mine? Say, for example, if you keep on paying EMIs then the loan will be paid off in the year 2025. And if you make some part payments, loan will be paid off by 2022. Fine. But the question is - Will you be needing money that time around for any financial goal which is critical like child's higher education goal etc.?
If your answer is 'Yes' - then don't make part payment now. Instead invest the available money at right kind of assets to achieve the goal. Otherwise you will be in a difficult situation - known as 'asset rich, cash poor' - and you may again need to take a loan to fulfill the goal then.
Is more than half the loan tenure over now?
If 'Yes' then you are not going to save much by repaying now because major portion of the interest is already paid. As loan EMI is calculated on basis of 'reducing balance' method - you pay more interest during the 1st half of the loan tenure and more principal during the later half the tenure.
Hope this will help you in taking a logical and right step towards managing your loan. There are more to it than the above thumb rules. Thus it is highly recommended that you consult your financial advisor regarding this and take an informed decision.
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