Should I invest or pay off debt first?

The decision depends on factors such as loan interest rate, tax treatment, investment risk, and personal comfort with debt. Comparing the post-tax cost of debt with potential investment returns can help frame the choice.

What is the psychological cost of debt?

Beyond mathematics, debt can create mental stress due to fixed repayment obligations. For some individuals, reducing or eliminating debt improves financial confidence and peace of mind.

Does home loan prepayment save tax?

Home loan prepayment reduces outstanding principal and future interest payments. Since interest payments may be eligible for tax deductions under certain regimes, prepaying can lower tax benefits while reducing total interest outflow.

Loan vs Investment: The Real Cost of Debt Explained

The cost of debt is the effective interest rate you pay on a loan. If your loan interest rate (e.g., 9%) is higher than your potential investment return (e.g., 7% FD), it may be mathematically preferable to reduce debt, depending on return assumptions and risk tolerance. If your investments can earn significantly more (e.g., 12% Equity) than the loan costs, investing is often considered superior, subject to market risk.

This guide is the master decision framework for all loan and debt-related choices on Hisabhkaro.

Who this guide is for: Borrowers with surplus cash who are torn between becoming debt-free and growing their wealth through investments.

You have received a bonus of ₹5 Lakhs. Your home loan is running at 8.5% interest. Should you close a part of the loan, or should you start a SIP in mutual funds?

1. The Classic Dilemma

This is the most common debate in personal finance. One path offers the emotional freedom of being debt-free. The other offers the mathematical promise of wealth creation. Let's solve this using data.

2. Debt is "Reverse Compounding"

Albert Einstein called compound interest the "eighth wonder of the world." But he didn't mention that it works both ways.

When you invest, compounding works for you. When you have a loan, compounding works against you. This is why credit card debt (36-40% interest) destroys wealth so fast.

If you are new to this concept, first understand how inflation silently destroys purchasing power , because all debt vs investment decisions are inflation-adjusted decisions.

The Hurdle Rate: Your loan interest rate is your "Hurdle Rate." Any investment you make MUST generate post-tax returns higher than this rate to make sense.

Check Prepayment Impact

See how prepaying just ₹1 Lakh today can save you lakhs in future interest.

Calculate Interest Savings

3. The Math: 8.5% Loan vs 12% Equity

Let's compare two scenarios for a surplus of ₹5 Lakhs over a 15-year period.

Parameter	Option A: Prepay Loan	Option B: Invest (Equity MF)
Rate	8.5% (Saved)	12% (Earned)
Risk	Zero (Guaranteed)	Moderate/High (Market)
Tax Impact	Loss of Tax Benefit*	12.5% LTCG Tax
Value after 15 Years	₹17.0 Lakhs (Saved)	₹27.3 Lakhs (Earned)
Net Benefit	-	+ ₹10.3 Lakhs

Illustrative Outcome: In this example, higher assumed investment returns result in a larger projected value over long periods. Actual outcomes depend on market performance, taxes, and individual circumstances.

Note: Effective home loan cost may be lower after tax deductions (Sec 24b), especially in the old tax regime. Always compare post-tax numbers.

Visualize the Growth

See how your ₹5 Lakhs grows at 12% vs 8.5% over time.

Open SIP Calculator

You can also evaluate loan affordability using our EMI Calculator .

4. The Risk Factor (Guaranteed vs Volatile)

Math isn't everything. Prepaying a loan gives you a guaranteed, risk-free return equal to the interest rate. No investment product guarantees 8.5% tax-free returns risk-free.

When to Prepay (Ignore the Math):

High Interest Debt: Credit Cards (36%), Personal Loans (11-14%). Always pay these first. Investing while holding these is financial suicide.
Unstable Income: If you fear job loss, reducing debt reduces your monthly obligation (EMI), reducing stress.

We explain the mechanics and timing of this in detail in our home loan prepayment guide, including real amortization tables.

5. The "Sleep Well" Factor

Behavioral finance argues that the peace of mind from owning your home 100% debt-free is worth more than the extra ₹10 Lakhs you might make in the stock market.

The Middle Path Strategy:

Pay off all high-interest debt immediately.
Invest heavily for long-term goals (Equity SIPs).
Use annual bonuses to make partial prepayments on your home loan to reduce tenure, not EMI.