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RELATEDKEYWORDS:TheNational | Rupee | Investments | Invest | Interest

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Investintaxfreebondsorprepayyourhomeloan?

NarendraNathan|Oct28,2013,05.04AMIST
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Themarketisfloodedwithtaxfreebonds.Besidesthethreeexistingofferings(seetable),the
NationalHousingBankisalsoexpectedtohitthemarketsoon.Thesearecompellinginvestment
optionsbecausethetaxfreeinterestratesofferedareveryhighandcomparablewiththepretax
ratesonbankfixeddeposits.
Thedecisionmaynotbethateasyforthosewithahomeloantopay.Thecommonrefrainisthat
ifthereisanysurplusmoney,shouldn'titbeusedtoprepaytheloan?Mostborrowersmayoptto
prepaytheirloansthaninvestintaxfreebonds.Ifyouarefacedwiththesamedilemma,consider
thesefactorsbeforeyoudecide.
Lookatprepaymentasaninvestment
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Muchoftheconfusiongetsclearedifyouseedebtprepaymentasjustanotherinvestment.Ifyou
prepay`1lakhofapersonalloanwhichwaschargingyouaninterestrateof15%,yousave
`15,000ininterestperannum.Andsincemoneysavedismoneyearned,your`1lakhwill
effectivelyearnyou`15,000inayear.Evaluateyourdebtsonthebasisoftheinterestyouare
payingandstartwithrepayingthecostliestones.
Thecreditcardbalanceandpersonalloansshouldbethefirstinyourcrosshairs.Itdoesn'tmake
sensetokeepmoneyinafixeddepositthatfetchesonly9%whenyouhaveacreditcard
outstandingwithinterestcostofaround42%andpersonalloanswithinterestcostofaround15%.
Youmayalsoencountersituationswheretheloansarecheaperthanwhatyourinvestmentscan
earn.That'swhenyoushouldstopprepayingtheloanandstartinvesting."Followthesimplerule
thatthereturnfromtheinvestmentsshouldbemorethantheinterestontheloans,"saysJaya

NagarmatfromInvestorShoppe.

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Asmallcaveathere:Youmustalsoconsidertherisksinvolvedintheinvestmentswhenyou
makethecomparison.Youshouldonlyconsiderrelativelysafeinvestmentssuchasbankfixed
depositsandbonds.

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Taketaxintoconsideration
Themaximumreturnsofferedbythetaxfreebondscurrentlyonofferis8.92%,sothe
prepaymentofloanscontinuestobeaviableoptionifonegoeswiththeabovementionedsimple
rule.However,thetaxbenefitsoncertainloanscanchangetheequationinfavourofinvesting.
Theeffectivecostofsomeloanscomesdownifthetaxbenefitsontheinterestistakeninto
account.
"Interestpaidoneducationloanisdeductablefor8yearsfromthestartingdateofrepayment,"
saysSandeepShanbhag,director,WonderlandConsultants.Forsomeoneearningover`10lakha
year,thecostoftheeducationloancomesdownfrom13%to8.98%.Similarly,theeffectivecostof
ahousingloanat10.25%alsocomesdownto7.08%fortheborrowersinthe30.9%taxbracket.
"Theinvestorshouldnotprepaythehousingloanifheisinthehighesttaxbracket.Else,hecan
payofftheloaninsteadofinvesting,"saysNagarmat.
Here'sanothercaveat:ifthehouseisselfoccupied,youcanclaimamaximumdeductionof`1.5
lakhinayear.Ifyourloanamountisverylargeandtheannualinterestfarexceedsthe`1.5lakh
limit,itmaystillmakesensetoprepaythehomeloanthaninvestinthebonds.Thereisnolimiton
thedeductionoftheinterestifthehousehasbeenrentedout.
Anotherpointthatneedsconsiderationisthetaxtreatmentofthereturnsfromtheinvestment.
Theposttaxreturnofafixeddepositthatoffers9%isonly6.22%foraninvestorinthe30.9%tax
bracket.Thisisbelowthe7.08%effectivecostofthehousingloan.Butthe8.92%couponrate
offeredontaxfreebondsissignificantlyhigherthantheeffectivecostofthehousingloanfor
investorsinthe20.6%and30.9%taxbrackets.Theseinvestorsshouldusesurplusfundsinthis
order:firstinvestintaxfreebonds,thenprepayhomeloanandlastlyinvestinFDs.
InterestratesareexpectedtofalloncetheRBIisdonewithitsmeasurestostabilisetherupeeand
controlinflation.Ifratesfall,thetaxfreebondsshouldfetchgoodreturnsinthemediumtolong
term.However,don'tthinkthatthisstrategyiscompletelydevoidofrisks.Mosthousingloansare
notfixedbutatfloatingratesofinterest.Intheunlikelyeventofratesgoingup,theEMIwillalso
rise.Ontheotherhand,thevalueofthelongtermtaxfreebondsinthesecondarybondmarket
willcomedown.
Futurerequirements
Thefuturecashflowrequirementisanotherthingtoconsiderwhenprepayingyourhomeloan.It
isalwaysbettertokeepsomeextramoneyinhandforcontingencies.Ifyouprepayyourhousing
loantoyourmaximumabilityandneedmoneyinfutureforsomeunexpectedevent,youwillbe
forcedtogoforpersonalloans.Toconclude,debtssuchasahomeloanareshouldnotbeprepaid
aggressively.Irrespectiveofwhetherornotyouprepayyourloan,theultimateobjectiveistohave
alargepoolofinvestmentsandnodebtbythetimeyouretire.Allthesedebtversusinvestment
discussionsareonlyshorttermdecisions.

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