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Home >Money >Personal Finance >Should you start SIP or prepay home loan?

Many homebuyers go through the same journey: They take a home loan when purchasing the house. When buying the property, the equated monthly instalment (EMI) forms a significant portion of the borrowers' salaries.

A few years later, after increments and job change, buyers find they are left with surplus cash at the end of each month. At this point, many ask the question: Should they prepay the home loan with funds or should they start a systematic investment plan (SIP) and invest in a mutual fund.

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If you strictly look at numbers, the thumb rule says that if you can generate better post-tax returns than your home loan's interest rate, don't prepay.

For example, home loans from banks at present could be at 7-8% rate. Most planners take 10% post-tax returns for equities over the long term. At this stage, starting an SIP is a better option. The investment returns are about two percentage points higher than home loan interest rate.

Many planners, however, suggest borrowers clear the home loan. Investment advisors usually don't prefer debt. There's a reason for it. In an unfortunate event, family finances get impacted. For example, a bread-earner could die. Any debt would deteriorate the finances further in such circumstances.

Whatever decision you take, ensure that you have essential safeguards in place before prepaying the home loan or starting an SIP. There should be an emergency fund to cover around one year of your expenses. If you don't have one, first create it with the surplus money. You should also have adequate life and health insurance.

Another thing to consider is whether you have any commitments some months down the line, and whether you have saved for it. For example, you may have to pay the tuition and school fee for children. Only if you have saved for such events, should you think of prepayment of loan or investment.

Do you have a personal finance query? Send them to mintmoney@livemint.com and get them answered by industry experts.

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