Prepay the home loan or invest the difference?

You have a spare ₹5 lakh, a home loan at 8.5%, and an equity portfolio that has returned 12%. The internet says invest. The internet is only half right.

The arithmetic case for investing

If equity returns 12% after tax and the loan costs 8.5%, the 3.5-point spread favours investing. Over long periods, and on average, this holds. It is the argument every calculator makes.

The three things the arithmetic leaves out

First, the loan rate is certain and the equity return is not — you are comparing a guaranteed cost with an expected return. Second, the effective loan rate is lower if you claim the Section 24(b) deduction under the old regime, which cuts the spread. Third, prepayment early in the tenure removes interest at a rate no risk-free investment matches.

Where prepayment wins outright

In the first third of the tenure, when nearly every rupee of the EMI is interest. One extra EMI a year on a 20-year loan typically ends it three to four years early. Run your loan through the home loan EMI calculator and look at the year-by-year balance — the first ten years are the ones worth attacking.

Where investing wins

Late in the tenure, when the outstanding is small and mostly principal, and for anyone whose emergency fund and insurance are already in place with a long horizon ahead.

The order that works for most people

Emergency fund of six months first. Term and health insurance next. Then split surplus between prepayment and investing rather than choosing one — a 50/50 split captures most of the mathematical benefit and most of the psychological one.

One practical note

Ask the lender to reduce the tenure rather than the EMI when you prepay. Keeping the EMI constant is what converts a prepayment into years off the loan.