ELSS returns may look better that home loan repayment benefits, given their attractive returns. But it is still better to opt for the latter, says Nikhil Walavalkar
THIS is a scenario that confronts most home loan borrowers at some point of time. It is close to the end of the fiscal, you have received some annual payouts and have a surplus of Rs 1 lakh lying in your bank account. Do you
a) repay your home loan?
or
b) do you invest the money in an ELSS scheme?
Both, home loan pre-payment and investment in mutual funds get you the same tax breaks. Of course this dilemma would not come into play if the total repayment that you make during the year through your monthly instalments, includes a principal repayment of close to Rs 1 lakh. If you are already repaying Rs 1 lakh of you loan through your instalments, there is no headroom. This by itself would qualify as investment up to the Rs 1 lakh limit under Section 80C.
In other words, those borrowers who have to make this choice include a new borrower (whose EMIs are largely made up of interest payment) or a borrower with a relatively small loan (where repayment of principal is far below Rs 1 lakh per year).
Repayment of home loan reduces your interest burden while investing in ELSS gives you the upside of equities. According to Value Research, as of February 4, ELSS as a category has posted 84.29% returns over the past one year. As markets turn weak, ELSS turns out to be more attractive. But before we take a call, let us look at some details.
Home loan prepayment brings in tax relief in two ways. The interest component in the EMI provides relief under section 24 of the Income Tax Act, 1981, to the extent of Rs 1.5 lakh in a financial year. The home loan principal repayment is eligible for tax relief under section 80C up to Rs 100,000 per financial year. This is the same overall Rs 1 lakh limit where you get tax breaks for investing in ELSS schemes.
You can get an idea of how much principal and how much interest you are paying through the provisional statement that lenders issue at the beginning of the fiscal for tax purposes. For several borrowers, the principal amount may be less than Rs 100,000. The borrower, therefore, has to invest the shortfall in some instrument such as public provident fund, mutual funds or life insurance to avail of full tax benefits. Alternatively, he can prepay his loan. While there is no cash return here, the borrower will save a large amount of interest on the pre-paid amount for the term of the loan. Conservative investors have traditionally shunned loans in favour of a debt-free status. But the Rs 1.5 fiscal incentive to a borrower makes investors think for a while.
"If you have a very long-term home-loan outstanding, it makes sense to prepay the home loan. For loans outstanding with short timeframe, typically below five years, taxpayers may consider investing in ELSS," says Veer Sardesai, a Pune-based financial planner. Given the fiscal incentives, one should not repay if the cost of the home loan is lower than the post tax returns one can expect from investing in ELSS. If a pre-tax home loan rate stands at 12% and the investor is expecting a post tax annualised yield of anything more than 12%, it makes sense to invest in that asset (read ELSS).
While 12% may appear high from the fixed income market, equities still hold promise over the long-term. "Investors can reasonably expect 15-18% returns per year from the equity markets over the next three years," says Vinod Ohri, president — equity, Gupta Equities.
But do remember that bankers impose restrictions on prepayment. Some do not allow repayment in the first three years. Some charge hefty pre-payment fee and processing fee. But many banks do not bother if the borrower is repaying a small part of the loan though his surplus funds. When you do the cost-benefit analysis, do take into account these costs.
ELSS returns though look better than the home loan repayment benefits. It must be noted that home loan repayment is inevitable and ELSS need not be the value accretive always —losses cannot be ruled out in extreme cases. According to Value Research, the three years returns stand at 5.61% as on February 4, 2010.
Many anticipate a rate hike in the next credit policy review. If you are on the floating rate option and your banker follows the central banker, you may end up paying higher. Better repay your home loan now. This will help minimise the impact later.
