Prepay the loan, or invest?

You have a spare ₹5 lakh and a home loan at 8.5%. Do you put it into the loan, or into an index fund that has historically returned about 12%? The comparison is not as simple as 12 beats 8.5, because the two returns are not the same kind of number.

Compare like with like

Prepaying a loan gives you a guaranteed, risk-free, tax-free return equal to your interest rate. Every rupee you prepay stops 8.5% of interest with total certainty, and there is no tax on the saving because it is avoided expenditure, not income.

Equity returns are none of those things. The 12% long-run average is a historical figure, arrives with drawdowns of 30% or more along the way, and is taxed — 12.5% on long-term equity gains above ₹1.25 lakh a year.

So the honest comparison is roughly 8.5% guaranteed and tax-free against about 10.5% after tax, uncertain, over a long horizon. The equity edge is real but far narrower than the headline suggests.

The tax regime changes the answer

Under the old regime, if you are claiming the full ₹2 lakh of interest under Section 24(b) at a 30% slab, your effective loan cost drops to roughly 5.9%. Against that, investing wins clearly. Note that as the loan runs down, annual interest eventually falls below ₹2 lakh and the benefit shrinks with it.

Under the new regime, a self-occupied property gets no interest deduction at all, so your loan costs the full 8.5%. Prepaying becomes much more attractive — and since the new regime is now the default, this is the situation most borrowers are in.

Where the two are not really in competition

Prepayment is worth most in the early years, when the balance and therefore the interest are at their highest. A ₹5 lakh prepayment in year two of a twenty-year loan saves roughly three times what the same amount saves in year twelve. Investment, by contrast, is worth most when given the longest possible time. Both arguments point the same way: act early, whichever you choose.

A practical split

For most people the answer is not either-or:

• First, hold six months of expenses in a liquid emergency fund. Neither option matters if a job loss forces you to borrow at 18%.
• Second, clear every debt costing more than your home loan — cards at 42%, personal loans at 14%. This is not a close call.
• Third, capture any employer match on retirement contributions. That is an instant guaranteed return.
• Then split surplus between prepayment and investing. A common approach is prepaying one extra EMI a year — enough to end a twenty-year loan around year seventeen — while investing the rest.

The part the spreadsheet misses

A paid-off home changes what you can risk. It lowers your fixed monthly obligation, which makes a career change, a business, or a bad year survivable. Investors who ignore this optimise the return and increase the fragility. If a large loan keeps you awake, prepaying it is a rational purchase of peace of mind, even at a small mathematical cost.

Model both paths with the prepayment calculator and the SIP calculator before deciding.

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