Should you save or prepay your loan?

ot a question about your money? What you should or should not do with it?

Our expert Uma Shashikant has the answers.

Age: 24 years
Monthly income: Rs 15,000

My expenses are about Rs 5,000 per month as I share the household expenses with my father. 

My father has a debt of about Rs 8,00,000 but is unable to save due to the uncertainty of his business.

I would like to repay this debt in the next five years. Kindly suggest the savings per month and also the savings instruments. I don't intend getting married during this period and neither am I expecting any major expenses.

- Jesal Trivedi  

Since the loan amount by itself is large, adding the interest element could make it quite big. It would take you a while to clear it off. 

I suggest that you divide your savings in two parts. Use one to repay the loan, and use the other to invest in a combination of equity and debt. Do this over the next five years you have in mind. 

At the end of this period, you can assess whether you need to liquidate your investments to pay the balance loan amount, or your father has been able to pay it off himself.

If you are sure you have to bear it entirely, the simplest thing to do is to pay the loan, rather than save (unless your return on investment is higher than the interest on the loan). 

Can you augment your income in any way?
Can your father's business issues be addressed so that the income improves?
Do you have any asset that can be sold to clear off the debt?

These options could be yield better results than resigning to the present position.

• Smart ways to manage your money

Age: 23 years
Monthly income: Rs 10,000 to Rs 12,000
Expenses: Every month I spend Rs 4,000 on my home loan and Rs 4,000 as monthly expenses.
Savings: I have Rs 50,000 invested which I earn some amount by way of interest.

Should I continue to earn interest on Rs 50,000 or must I reduce my loan amount?

- Sagar Chandak

The only question to ask is if the interest rate you are earning is higher than the rate you are paying on your home loan. 

If the interest rate on your home loan is higher, repay it.

But, ensure that you have checked the pre-payment terms of your loan. If there are restrictions and penalties, understand them before prepaying the loan.

If your investment gives a better rate, keep it. Be sure that your investment is secure and does not have any risk of default.

• Your questions on education loans answered

Age: 22 years
Earnings: I would start to earn a gross pay package of around Rs 2,40,000 in a months time.
Loans: I have an educational loan for five years with an Equated Monthly Installment of Rs 3,500. 

Should I focus on prepaying my loan or investing my earnings?
Is a Public Provident Fund account wise?

- Srinivas Pai

If your loan is at a concessional rate, pay the EMI.  If the rate is the normal market rate, pay it off first. You will have to use the same principle that I mentioned in my answer above.

You will require some investments to be able to save some taxes. To know the various tax-saving options read All about Section 80C.

Consider a tax-saving equity fund, that will give you both growth and tax saving. Read Make money through ELSS funds to understand this investment.

PPF is a good choice, because the interest and principal are exempt from income tax. The limitation is that you do not have liquidity. Since you may need the money for unexpected expenses, do not invest more than 10% in the PPF account. Check How to open a PPF account.  

If you have the discipline of saving every month, you can still invest around 30% to 40% of your savings in debt (fixed return) instruments or debt mutual funds (funds that invest in such instruments). The rest you can invest in equity mutual funds for the long term. Read How to invest in a mutual fund.

Illustration: Dominic Xavier

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