SIP top-up or home loan prepayment: What’s the smarter use of your salary hike?

While both options can strengthen your financial future, the right choice depends on factors such as your home loan interest rate, expected mutual fund returns, remaining loan tenure, taxation, and overall financial goals. 

Before you decide where your salary increment should go, it’s worth comparing both strategies to understand which one can leave you financially better off in the long run.

How to use your salary hike wisely?

Individuals should not make decisions just based on comparing the home loan interest rate with equity returns; one should begin by evaluating their overall financial profile, such as emergency corpus, insurance cover, cash flow stability, and progress towards long-term goals such as retirement or children’s education.

For instance, consider an individual who earns Rs 12 lakh CTC and receives a 10% salary hike, increasing annual income by Rs 1.2 lakh, along with a Rs 2 lakh annual performance bonus. 

Instead of using the entire additional income for loan repayment, investing ot lifestyle upgrades, they could increase their SIP by Rs 8,000 per month, Rs 96,000 annually from the salary hike, and utilise Rs 1 lakh from the annual bonus towards home loan prepayment, while keeping the remaining amount for discretionary spending or contingency needs. 

“If long-term investments are inadequate to meet future goals, it will be ideal to prioritize directing surplus cash flows towards SIPs. If the home loan is placing significant pressure on monthly cash flows or creating financial stress, accelerating loan repayment could be the better choice,” says Amitabh Lara, Executive Director at Anand Rathi Wealth Ltd. 

This approach enables them to benefit from long-term wealth creation through compounding while simultaneously reducing their loan burden and interest costs.

“The ideal takeaway for individuals is to prioritize allocating 50 to 60% of surplus cash flows towards the area; whatever remains can be evenly distributed across other financial objectives,” he noted. 

Which factors should drive your decision?

Individuals should consider that there is no one-size-fits-all approach. The ideal strategy is to budget the cash flows in a manner that aligns with one’s financial goals, risk profile, income stability, and liabilities. 

“One can consider building a budgeting framework like 40% of cash flows towards regular household expenses, 25% towards EMIs, 25% towards long-term investments like SIPs, 5% towards building an emergency fund, and the remaining 5% towards contingency reserves for short-term or unforeseen expenses,” Amitabh Lara stressed. 

Building a broad cash flow budgeting framework like this helps to maintain the right balance between meeting financial obligations, building long-term wealth, and maintaining adequate financial resilience.

A salary hike is an opportunity for individuals to strengthen their overall financial position as it creates additional surplus cash flows. 

However, one should consider that instead of allocating the entire surplus towards a single objective, they should plan it strategically by assessing their overall financial profile to identify any shortfalls in their financial objectives, such as an inadequate emergency fund, insufficient investments to reach desired long-term goals, or a high debt burden. 

One should consider prioritizing additional income to be used to fill the financial gaps, says Lara, adding that the remaining surplus can be allocated towards increasing SIP contributions, discretionary spending, and contingency reserves. 

This strategic approach helps to ensure that rising income converts into stronger financial well-being rather than just spending on higher consumption.

How to balance wealth creation and home loan repayment?

Individuals should consider avoiding treating wealth creation and home loan repayment as exclusive goals. One should consider pursuing both in a disciplined manner. 

They can begin by building a strong financial foundation by maintaining an emergency corpus, having adequate insurance coverage, and a disciplined investment plan.

“Thereafter, they can continue their SIPs for long-term wealth creation while making periodic home loan prepayments using annual bonuses, incentives or a portion of salary increments, instead of disrupting their regular investments,” he said.  

Reviewing this strategy periodically as income grows and liabilities reduce can help individuals steadily build wealth while lowering their debt burden, he added.  

“For individuals with a 10–15-year+ investment horizon, stable cash flows, and adequate emergency savings, increasing SIP investments may potentially create greater long-term wealth than aggressively prepaying a home loan,” said Sameep Singh, Head of Investments at Policybazaar. 

However, home loan prepayment may still be preferable for those who are nearing retirement, have high-interest loans, or value the certainty and peace of mind of becoming debt-free, Sameep Singh added. 

The ultimate objective should not be to become debt-free at the earliest, but to build financial independence with a healthy balance of assets, liabilities, and cash flows.

Disclaimer: This article is for informational purposes only and should not be considered financial or investment advice. Please consult a qualified financial advisor before making any investment or loan repayment decisions based on your financial goals, risk appetite, and personal circumstances.

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