Home loan dilemma: Should you prepay or invest after repo rate cut?

The Reserve Bank of India’s (RBI) 100-basis-point repo rate cut this calendar year has brought relief for home loan borrowers through lower EMIs, but raised a dilemma: should they prepay their loans or invest the surplus in equities?

Repo rate cut: Impact on home loan borrowers

All new retail floating-rate loans sanctioned after October 1, 2019, are linked to an external benchmark, which is the repo rate for most banks.

The RBI’s repo rate cut directly affects home loan interest rates, which are likely to decrease, benefitting borrowers as it would lead to lower EMIs or shorter loan tenures.

For instance, if your Rs 50-lakh, 20-year home loan at 8.5 percent interest was disbursed in January 2025, you’ll benefit from a 100-bps rate reduction once your bank resets the interest rate after the June policy action. This would shorten your loan tenure to 206 months and save around Rs 14.78 lakh in interest payments.

If you choose to reduce your EMI amount instead, your interest savings will be relatively lower. You will save around Rs 7.12 lakh instead of Rs 14.78 lakh by keeping EMIs constant.

 

Anuj Kesarwani, Founder of Zenith Finserve, advises borrowers to maintain the same EMI amount after a rate cut if their goal is to save on interest and pay off the loan quickly. Alternatively, if borrowers prefer having more disposable income or investing the surplus, while still benefiting from interest savings, they can opt to reduce their EMIs.

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Prepaying home loan vs investing

Dev Ashish, Founder of StableInvestor, a financial planning and investment advisory firm, advises that prepaying a home loan can save significant interest, but one shouldn’t be over-aggressive on it. He recommends striking a balance between loan prepayment and other financial priorities, acknowledging that opinions on prepayment versus investment may vary.

Depending on the asset class, your investment would generate returns that may be higher or lower than the savings on loan interest. The following table illustrates what happens when you invest the prepayment amount in equity, debt, and gold.

Adhil Shetty, CEO of Bankbazaar.com, an online financial marketplace that helps people compare and choose financial products, notes that prepaying 5 percent of the outstanding loan amount annually can reduce interest burden by 48 percent. He suggests that investing the prepayment amount could yield significant returns, potentially exceeding interest savings. Returns would depend on the investment choice, with equities offering potentially higher returns than debt investments.

Ashish notes that while equity markets can deliver 10-12 percent average returns in the long term, outperforming home loan rates, it’s crucial to understand that this is a potential, not a promise. Equities can’t guarantee consistent returns year after year, despite their long-term averages.

Not prepaying the loan might seem like a good decision if investments perform well, but if the market declines, the decision may not yield favourable results, at least in the short term.

Ashish emphasises that mutual funds don’t offer guaranteed returns, but historical data suggests that equity mutual funds tend to outperform home loan interest rates over the long term. From a mathematical standpoint, these favour investment over aggressive prepayment, despite potential short-term market volatility.

Shetty stresses that financial planning is not a one-size-fits-all approach. If closing the loan early is the priority, prepayment is the better option, even if equities offer higher returns. However, if other financial goals are a priority, investing—even in low-risk debt instruments that offer capital protection—may be more suitable, depending on individual financial needs and goals.

Ultimately, the “right” decision depends on your personal goals, risk appetite, and financial situation.

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Consider your life stage

Ashish suggests that one’s life stage is crucial in deciding between loan prepayment and investing. For younger individuals with decades to invest, investing may be more attractive than prepaying. However, for those nearing retirement with significant outstanding loans, prepaying might be a wiser choice, especially in current volatile market conditions.