Many salaried individuals switch jobs for a salary hike. After the job change, however, they are often in a dilemma of whether to prepay their home loan first or increase their monthly mutual fund SIP amount with the increase in take-home pay.
One such individual recently asked FE Money whether he should focus on closing his home loan first or increasing his SIP amount as he had received a 40% salary hike after joining a new company.
The reader asked: My salary has increased by 40% as I have recently switched a job. With more money in hand, should I pay my home loan first or increase my SIP amount? Which will be more beneficial in the long run?
This individual has taken a Rs 50 lakh home loan for 28 years and he is paying approx. Rs 45,000 per month as EMI for the last two years. He is also doing a monthly SIP of Rs 10,000 in a mutual fund scheme.
Viplav Majumdar, a Certified Financial Planner and Director of Planyourworld Training Academy answers the reader’s query:
Majumdar said this person should increase SIP, as this is in Equity. In the long run, equity will give much more return than the interest he is paying on his home loan. Moreover, if he chooses to pay the home loan first then he will make a loss in total. This will be visible in 10 years, the net worth of the person will be less with the decision to prepay the home loan. If he increases SIP, his net worth will be more.
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“The core idea is to get a return on borrowed money if you are paying 9% on the loan amount and if you are getting 12% in regular plans of mutual funds and 13.5% in Direct plans, you are getting much more return than the home loan interest,” said Majumdar.
“If he increases SIP, he will have liquidity at any point of time to prepay the home loan. In case, he just wants to get rid of the debt. He should choose the fund wisely and he should invest in a Direct plan of mutual funds. In this manner, he will increase his returns by 1.5% yearly. This will ultimately accumulate wealth faster than investment through banks or agents.
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