Is it better to pay off your loan before investing?

Living a debt-free life and growing your net worth through investments are two of the most important goals of any financially savvy person. While one can do both, however, at times you may decide on taking a Personal Loan and postponing your investment goals. The loan could be for an emergency hospitalisation, funding education, buying gadgets and appliances, or even for funding emergency repairs in your home.

But, is it possible to pay off your loan and invest for the future at the same time? Let us find out.

Choose the loan terms wisely

If you plan to take a Personal Loan, the first step is to understand and choose the terms and conditions of your loan carefully. You must be aware of these monetary values that matter in the loan process. These values will define your ability to invest while paying off your loan.

• Interest rate: This is the percentage charged by your loan service provider. The lower the Personal Loan interest rate, the less you pay above the principal amount. 
• Equated Monthly Installments (EMI): This is the amount you will pay every month for the loan duration. It consists of payment towards reducing your principal amount as well as repayment towards interest.
• Loan tenure: This is the time frame in which you must pay off the loan.

Interest rates vs returns 

Today, Personal Loan interest rates from a credible service provider start at around 9.15% p.a. and go as high as 49%. On the other hand, the returns earned on various investment instruments can be much lower.

For instance, your Savings Account may provide interest earnings ranging between 2.5% and 3.5%. You can earn interest on your Fixed Deposit between 3 and 7% for a tenure of 7 days to 10 years. When you go for mutual funds, the returns can range between 12% for equity funds and 7.5% for debt funds. However, the risk is also higher and there is potential for your principal investment to reduce. 

When we compare Personal Loan interest rates and returns on investments, it becomes evident that you must allocate more funds toward paying off your loans faster. Thus it is advisable to put all surplus funds towards your EMI.

Also Read :Top 3 tax benefits of Personal Loans

Personal Loan lock-in period 

Your Personal Loan comes with a lock-in of, say, 12 months. During this time frame, you will be unable to pay back your loan faster even if you have surplus funds. Instead, you could invest surplus funds towards a liquid fund. A liquid fund earns a higher interest than your Fixed Deposit. Once the lock-in period lapses, these funds can be used to clear the loan.

How to pay off your loan faster

Here are the two ways that you can clear your loan faster:

Renegotiate your loan terms

Renegotiate the terms and conditions with your bank, based on your new cash flow limits. You can go for a higher EMI value, reduce the tenure, and pay off your loan faster. The sooner you pay it off, the more you save on interest payments.

Also Read :Top Reasons to Start Investing at an Early Age

Foreclose your loan

Say you have a lump sum sitting in your bank account, and it is enough to cover the outstanding principal amount. You can consider foreclosing the loan; this is an opportunity to completely pay off the pending loan amount in one shot.

Your bank will charge you a one-time foreclosure charge, a percentage of the principal outstanding amount. For instance, Axis Bank charges up to 5% for Personal Loan foreclosures. In one shot, you become debt-free.

The takeaway 

When taking a Personal Loan, ensure that the terms and conditions chosen by you are optimal for you, so that you can clear it faster. You can avail of Personal Loans of up to ₹40 lakhs from Axis Bank at attractive interest rates, and a turnaround time of four days. The repayment tenure ranges between 12 and 84 months. Personal Loan interest rates start at 10.49%. Make sure that your EMI value aligns with your monthly cashflows, and that you pay your EMI on time, to avoid extra charges and penalties.

Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.