Home Loan Prepayment vs Investment: What Should You Do?

On June 6, 2025, the Monetary Policy Committee of the Reserve Bank of India (RBI) slashed the repo rate by 50 basis points, bringing it down from 6.0% to 5.5%. This marks the third consecutive cut this year (25 bps cuts earlier in February and April) and reflects RBI’s intent to support growth while keeping inflation in check, aiming to maintain CPI inflation around 4% ± 2%.

The repo rate is the interest rate at which the RBI lends money to commercial banks. When the RBI cuts the repo rate, banks can borrow money at a lower cost, which typically leads to lower loan interest rates for consumers. In 2025, the RBI has cut the repo rate by 100 basis points, making home loans cheaper for both new and existing borrowers.

So what does this mean for you, especially if you have a home loan? With banks reducing lending rates, your EMIs are likely to drop. But with lower rates, you also face a choice—do you prepay your home loan and save on interest, or invest that surplus money elsewhere for potentially better returns?

Let’s break it down.

How Major Banks Have Responded

Following the repo rate cut, most major banks responded quickly by lowering their lending rates.

• SBI reduced its repo-linked lending rate (RLLR) to 7.75% and its external benchmark lending rate (EBLR) to 8.15%, effective June 15 for both new and existing borrowers.
• Bank of Baroda matched with a 50 bps reduction to a repo-linked rate of 8.15% from June 7.
• Other major banks like HDFC, Canara Bank, and Bank of Maharashtra followed suit.

This benefits borrowers across home, auto, MSME, and personal loan segments.

Deposit rate cuts

• Leading banks, including SBI, HDFC, and ICICI lowered savings account and fixed deposit rates. SBI reduced its savings rate to around 2.5–2.65% and trimmed FD rates by 5–75 bps.
• ICICI Bank announced FD rates now ranging from 3–6.6%, and up to 7.1% for senior citizens.

While borrowers benefit, savers face reduced returns—a clear trade-off in this transmission phase.

Impact on Home Loan Borrowers

EMI savings and tenure gains

• Borrowers of a ₹50 lakh home loan could save approximately ₹3,100–3,200 monthly in EMI, translating to around ₹7.7 lakh over 20 years—if they opt to reduce EMIs while maintaining the original tenure.
• Opting instead to maintain EMI and shorten tenure could save up to ₹14.78 lakh in interest and shorten a 20-year loan by around three years.

Affordability boost

• Interest rates on home loans could drop below 7.75%, making repayment easier, especially benefiting first-time and middle-income buyers.
• The real estate sector, especially in Tier‑II cities, is optimistic—EMI reductions can stimulate demand and revive sentiment.

The Dilemma: Home Loan Prepayment or Investment?

With lower home loan interest rates, borrowers face a classic dilemma: should they use surplus funds for home loan prepayment or invest that money in other assets like equities or mutual funds?

Each choice has its own set of advantages and drawbacks.

Benefits of Home Loan Prepayment

• Interest Savings: The biggest benefit of home loan prepayment is the reduction in total interest paid over the loan tenure. By making lump-sum payments or increasing your EMI, you reduce the outstanding principal, which lowers future interest payments.
• Faster Debt-Free Status: Prepaying your home loan can help you become debt-free sooner, reducing financial stress and improving your credit score.
• Security and Peace of Mind: For many, reducing debt brings mental peace and greater financial security, especially as they approach retirement.
• Improved Cash Flow: Once your loan is repaid, you free up money for other financial goals or investments.

Drawbacks of Home Loan Prepayment

• Opportunity Cost: By using surplus funds for home loan prepayment, you might miss out on potentially higher returns from other investments, especially equities, which have historically delivered better long-term returns than home loan interest rates.
• Loss of Tax Benefits: Under the old tax regime, you can claim deductions on both principal and interest payments. Prepaying your loan reduces these benefits, which could increase your tax liability if you’re in a higher tax bracket.
• Reduced Liquidity: Tying up your funds in prepayment can reduce your financial flexibility, leaving you with less cash for emergencies or other opportunities.

Why Invest Instead of Prepaying

Investing your surplus funds, rather than using them for home loan prepayment, can be a smart move—especially if your expected investment returns exceed your home loan interest rate.

• Higher Potential Returns: Equity mutual funds have historically offered average annual returns of 10–12% over the long term, which is often higher than current home loan interest rates.
• Tax Efficiency: Investments in equities and mutual funds can be more tax-efficient, especially if held for the long term. Additionally, you continue to enjoy home loan tax benefits if you don’t prepay.
• Wealth Creation: Regular investments, such as SIPs in mutual funds, can help build a larger corpus over time compared to the interest saved by prepaying your loan.
• Flexibility: Investing keeps your money liquid and accessible, which can be useful for emergencies or future opportunities.

Factors to Consider Before Deciding

There is no universal answer to the home loan prepayment vs investment debate. Your decision should be based on your unique financial situation, goals, and risk appetite.

1. Interest Rate Comparison

• If your home loan interest rate is higher than potential investment returns, prepayment makes sense.
• If you can earn more from investments than you save on interest, investing is the smarter choice.

2. Tax Implications

• Under the old tax regime, home loan prepayment reduces your tax benefits. If you’re in a high tax bracket and fully utilize deductions, continuing the loan may be better.
• Under the new tax regime, where deductions are limited, prepaying the loan could be more attractive.

3. Financial Goals and Life Stage

• Younger borrowers with a longer investment horizon may benefit more from investing.
• Those nearing retirement or seeking financial security may prefer home loan prepayment.

4. Income Stability and Emergency Fund

• If your income is stable, you can consider increasing your EMI or investing.
• If your income is irregular, or you need liquidity, lump-sum prepayments may be safer.

5. Emotional Comfort

• Some people value the peace of mind that comes from being debt-free, even if the financial math favours investing.

 Strategies for Home Loan Prepayment and Investment

• Balance Both Approaches: You don’t have to choose one over the other. Consider prepaying a portion of your home loan while investing the rest of your surplus funds. This way, you reduce your debt and build wealth simultaneously
• Increase EMI When You Can: If your income rises, increasing your EMI can help you pay off your loan faster and save on interest, without the need for large lump-sum payments.
• Use Windfalls Wisely: Bonuses or unexpected income can be used for partial prepayment, while you continue investing regularly.
• Review Your Loan Terms: Ensure your home loan is linked to the repo rate to benefit from future rate cuts. If not, consider switching to a repo-linked loan.

Make the Right Choice for You

The RBI’s repo rate cuts have made home loans more affordable, but the decision between home loan prepayment and investment remains personal. Consider your loan interest rate, potential investment returns, tax benefits, financial goals, and risk appetite before making a decision.

How to proceed based on your situation

Note: You can negotiate with your bank or consider a balance transfer if your current rate isn’t aligned with the reduced repo‑linked rates.

Final Takeaways

• RBI has cut repo rate to 5.5%, and banks are swiftly passing on the benefit to borrowers.
• Home loan EMIs are cheaper; borrowers can save ₹3,000+ per month or shorten tenure significantly.
• Savers face lower returns in deposit accounts and FDs.
• If you prefer stability and want to be debt-free sooner, prepay. If you can weather volatility and aim for higher returns, invest.
• Consider a hybrid strategy: partial prepayment and diversified investments aligned with your goals, timeline, and risk appetite.

Whatever you choose, ensure you have an adequate emergency fund and that your decision aligns with your overall financial plan. Regularly review your strategy as interest rates and your circumstances change, so you can make the most of your money in any economic environment.

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Source: economictimes.indiatimes.com