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Home loan additional payment vs other investment

Discussion in 'Investor Resources & Tools' started by calvinhobbes, 19th Feb, 2011.

  1. calvinhobbes

    calvinhobbes Member

    Joined:
    7th Oct, 2010
    Posts:
    20
    Location:
    Brisbane
    Is there a formula available to calculate, if

    it is better off to put my extra money in my home loan account to reduce interest

    vs

    investing the money elsewhere.

    I am looking at finding the return i have to get elsewhere before tax to be comparable to my savings if i put the same money in the home loan account.
     
  2. Rod_WA

    Rod_WA Well-Known Member

    Joined:
    18th May, 2007
    Posts:
    324
    Location:
    Inglewood, WA
    Basic: Target rate = HLRate/(1-MTR)

    But it's not that simple, it depends on your circumstances, your risk tolerance, your plans, timeframes, and the assumptions on the outlook for investments.

    Looking at a single year makes it simple enough (assuming lump sums):

    Say your non-deductible home loan has an interest rate HLRate = 7.5% and you have $10k you are wondering what to do with. If this was to go in your HL then easy enough, you reduce you balance by $10k and reduce your next year interest by $750 (and future years' interest also).

    If you put the $10k in a bank account at 6.5%, then you'll earn $650 in interest but pay tax on this interest... if your marginal rate is MTR = .315 (31.5%), then you're left with $445.

    Not smart... you'd need to earn a return (interest rate) in excess of HLRate/(1-MTR)... there's the formula :)... at 31.5% MTR, you need to nail 11% return, and at 46.5% you're looking for 14%!!

    This is the basic reasoning for paying off your home loan before diving into other investments.

    BUT!! it's important to understand that by the time you've paid off your home loan, the cost of any investment is very likely to be more expensive... and you will have forgone any dividends/distributions along the way. Investments tend to grow over time and the return from these investments (eg capital growth + dividends) can work alongside franking credits, deductible interest payments, tax-deferred distributions, depreciation, CGT discount and other tax-effective bits and pieces to change the game.

    There's no easy way to model this (no simple formula:(). You need to consider sustainable investment returns over a number of years, and set up a spreadsheet that allows variation of some parameters (eg forward looking interest rates)... or go and see an accountant or financial adviser.
     
  3. calvinhobbes

    calvinhobbes Member

    Joined:
    7th Oct, 2010
    Posts:
    20
    Location:
    Brisbane
    My opinion

    Hello Smith,

    ....I will guess that you are from India. The rate of interest you are paying is very steep at 11%. So I would suggest that you pay this off first.

    If you do want to invest (not sure about your experience), I would suggest you to go with Mutual Funds. Try MutualFundsIndia.com - Indian Mutual Funds | Mutual Fund Magazine | MF Portfolio | MFI Scheme or Indian Stock Market >> Sensex >> Nifty >> Stock Prices >> Stock Recommendations >> Hot Stocks >> Stock Market Investing >> BSE >> NSE >> Derivatives >> Market Statistics >> Most Active Shares >> Penny Stocks India >> BSE index and securities informat and research a bit. A safe bet would be the balanced fund from HDFC Bank.

    Ofcourse you would have to work out your taxation issues.

    Calvin