Excess cash: Keep as savings or prepay loan?

My father just sold a property at Rs 20 lakh. He has taken two home loans of Rs 3 lakh each, and pays an interest of 14 per cent on both. He had also taken an education for me at 13 per cent.

We have Rs 20 lakh from the property; should we consider loan repayment or investment? Also, a major portion of his income goes towards his medical bills and equated monthly installments (EMI). He doesn't have much savings too. What should he do?

It pays to prepay!

When you have outstanding loans with such high interest rates, it is best to prepay if you have the means to do so.

Let's get an approximation on how much debt your father currently has:

The two home loans and an education loan makes his debt a total of Rs 9 lakh. If you follow a few steps you can have the cake and eat it too!

Step one: Evaluate your EMI outgo

If your father were to continue paying EMIs for the rest of the loan tenure at 14 and 13 per cent respectively, he would be shelling out more money in the long term. Instead, he could prepay all the three loans with prepayment penalty, which is unlikely to exceed 2-3 per cent on the outstanding amount.

Step two: Calculate the balance he would be left with after making the prepayment.

Rs 20 lakh - (Rs.9 lakh + Rs (9000 * 3)) = Rs 10.73 lakh

Rs 20 lakh: amount at disposal after selling the property

Rs 9 lakh: Total loan amount

Rs 9000: Prepayment charges (about 3% on the outstanding loan amount).

It is clear that even after paying all his debts, your father would still be left with Rs 10 lakh. So he could use this amount for investment purpose.

Step three: Don't put all your eggs in one basket

The remaining Rs 10 lakh can be invested in both equity and debt with a balanced exposure. An amount upto Rs 5 lakh can be invested in a risk free option such as a bank fixed deposit and the remaining Rs 5 lakh in equity funds. The latter can yield returns to the tune of 15-17 per cent. However, there is a downside to it, since equity investments are highly volatile in nature and come with a high risk quotient, the key to yielding good returns is to stay invested for a long time frame of 10-15 yrs.

Tip: If there is a sudden flow of money in the form of bonus, increment, property sale, it’s best to prepay your loan. By doing so you would be saving a significant amount that goes as interest.

Since there will be no EMIs after foreclosing the loan, your father could use this amount to add medical insurance, retirement plans in his portfolio.

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Abitha Deepak is Head of Content & Research at BankBazaar.com - An online marketplace where you can instantly get loan rate quotes, compare and apply online for all your personal loan, home loan and credit card needs from India's leading banks and NBFCs.

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