Mutual fund returns are rising, and investors are seeing significant gains. At the same time, home loan interest rates remain high, leaving many wondering if they should redeem their mutual funds and use the money to prepay their home loans. It’s a critical financial decision that depends on multiple factors.

Adhil Shetty, CEO of Bankbazaar.com, explains, “When mutual funds deliver higher returns, they can outpace the interest you pay on a home loan. For instance, if your mutual fund generates 12% annual returns while your home loan rate is 9%, you gain a 3% net advantage by staying invested. Redeeming the funds would mean losing this potential growth.”

However, this calculation depends on the consistency of mutual fund performance. Equity mutual funds, for instance, are market-linked and can fluctuate. If your investments are volatile, you may not see steady returns, making prepayment more attractive.

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Evaluate the Home Loan Interest

Home loans come with long tenures, which means paying high interest over time. Even if your interest rate is moderate, the cumulative interest can be significant. By prepaying a portion of the loan, you can reduce your principal amount and save on interest.

For example, if you have a Rs 50 lakh loan at 8.5% for 20 years, prepaying Rs 10 lakh can save you over Rs 13 lakh in interest and reduce your loan tenure by several years. This can bring peace of mind and financial freedom.

Tax Implications of Both Options

Mutual fund redemptions may trigger capital gains tax. The Long-Term Capital Gains (LTCG) tax on equity mutual funds is 12.5% for gains exceeding Rs 1.25 lakh per financial year, while capital gains on debt mutual funds is taxable at the recipient’s applicable income tax slab rate, rather than the new 12.5% LTCG tax rate.

On the other hand, home loans offer tax benefits under Sections 80C and 24(b). Prepaying the loan could reduce these deductions. If you rely on these tax breaks to lower your taxable income, it’s worth reconsidering full prepayment.

Liquidity Availability

Mutual funds are liquid investments, providing quick access to funds in emergencies. Home loans, once prepaid, lock your money into the property. If you don’t have a solid emergency fund, redeeming mutual funds to prepay a loan could leave you financially vulnerable.

When Should You Prepay?

  • High-Interest Loans: If your home loan interest rate is higher than your mutual fund returns, prepayment makes sense.
  • Near Retirement: Reducing liabilities as you approach retirement ensures financial stability.
  • Low-Risk Appetite: If market volatility makes you uncomfortable, clearing your debt could provide peace of mind.

When Should You Stay Invested?

  • High Fund Returns: If your mutual funds are delivering steady, high returns above the loan rate, staying invested can grow your wealth faster.
  • Tax Benefits: If you benefit significantly from home loan tax deductions, continuing EMIs could be more efficient.
  • Financial Goals: Redeeming mutual funds could disrupt long-term goals like retirement or a child’s education.

Balanced Approach

A balanced strategy can work well. You can use part of your mutual fund gains for partial prepayment while keeping the rest invested. This reduces your loan burden while letting you benefit from potential market growth. For example, if you have Rs 10 lakh in mutual funds, you could redeem Rs 5 lakh to prepay your loan. This would lower your EMI and interest costs while keeping Rs 5 lakh invested for further growth.

The decision to redeem mutual funds and prepay a home loan depends on your financial goals, risk appetite, and loan terms. Evaluate the opportunity cost, tax implications, and liquidity before making a choice.

In most cases, a balanced approach works best. Keep some investments growing while reducing your debt gradually. Consult a financial advisor if you’re unsure and make a decision that aligns with your long-term financial plans.