{"id":27160,"date":"2023-04-18T17:40:09","date_gmt":"2023-04-18T12:10:09","guid":{"rendered":"https:\/\/www.fundsindia.com\/blog\/?p=27160"},"modified":"2023-04-18T17:41:50","modified_gmt":"2023-04-18T12:11:50","slug":"invest-or-pay-off-debt-discover-which-option-is-best-for-you","status":"publish","type":"post","link":"https:\/\/www.fundsindia.com\/blog\/mf-research\/invest-or-pay-off-debt-discover-which-option-is-best-for-you\/27160","title":{"rendered":"Invest or Pay Off Debt? Discover Which Option is Best for You"},"content":{"rendered":"\n

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If you’re paying off a loan (say a home or car loan) and suddenly find yourself with some extra cash, you might be wondering whether to put it towards paying off the loan or investing.<\/p>\n\n\n\n

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It’s a tricky choice, but we’ve got some insights to help you make the right decision.<\/p>\n\n\n\n

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There are basically two lenses<\/strong> that you can use to solve the dilemma:<\/p>\n\n\n\n

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LENS 1: RATIONAL LENS<\/span><\/strong> <\/h3>\n\n\n\n

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The logical starting point is to compare the expected future return from your investment vs your current loan\u2019s interest rate. <\/p>\n\n\n\n

If,<\/p>\n\n\n\n

Expected Return from Investment >= Loan Interest Rate + Safety Margin (4%) = Invest<\/span><\/strong><\/p>\n\n\n\n

Expected Return from Investment < Loan Interest Rate + Safety Margin (4%) = Prepay Debt <\/span><\/strong><\/p>\n\n\n\n

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Why do we have a safety margin? <\/p>\n\n\n\n

  1. Buffer for rising interest rates <\/strong>– In the last few months the loan interest rates have increased from 6% to almost 8-9%. To provide for such rising rates an additional buffer is required. <\/li>
  2. Buffer for unexpected Investment returns<\/strong> – There can be times when the Investment returns do not turn out as expected, for such lower than expected return outcomes a buffer is required.  <\/li><\/ol>\n\n\n\n
    <\/div>\n\n\n\n

    Here is an example of how this works.<\/p>\n\n\n\n

    Assume you plan to invest in Equity Mutual Funds and your return expectation is around 12%.<\/p>\n\n\n\n

    Your current home loan rate is at 9%.<\/p>\n\n\n\n

    So,<\/p>\n\n\n\n

    Expected Return from Investment at 12% < 13% (i.e. Loan Interest Rate of 9% + Safety Margin of 4%)<\/strong><\/p>\n\n\n\n

    This means from a rational point of view, it\u2019s better to \u2018Prepay Debt\u2019<\/p>\n\n\n\n

    <\/p>\n\n\n\n

    LENS 2: EMOTIONAL LENS<\/span><\/strong><\/h3>\n\n\n\n

    Sure, the rational perspective makes logical sense. But let’s be real, when it comes to making decisions, emotions can play a huge role too. In fact, sometimes our emotions are just as important as the rational side of things, if not more.<\/p>\n\n\n\n

    So, let us also wear the emotional lens and check how you feel about the outstanding loan and monthly EMIs?<\/strong><\/p>\n\n\n\n

    <\/div>\n\n\n\n

    Question 1: Are you stressed that you are a single earner and have an unstable job\/income?<\/strong><\/p>\n\n\n\n