Should you prepay home loan before retiring?

Mohit works with a leading public sector bank and is due to retire in five years. He has two residential properties, one of which is mortgaged with his bank since he took a home loan. He gets a concessional rate by virtue of being an employee and has, therefore, not prepaid the loan. When he retires, he is looking at his pension, rental income and investment returns to sustain himself. He is not sure if he should repay the loan before retirement and be debt-free, or allow the loan to continue till he is 65. How should he decide?

There are two considerations when a loan is outstanding. The first is based on financial logic, and the second on emotional comfort. The financial logic is simple. If the money that is being used to repay the loan can earn a higher return than the cost of the loan, it is a good idea to let it grow. By reverse logic, it makes no sense keeping money in a 9% deposit when an 11% loan is due to be repaid. In the case of a home loan, the financial logic is simpler because there is an underlying asset that should be appreciating. If the value of house is growing at a rate that is higher than that of the loan, it is fine to keep the loan. The retirement corpus can be deployed elsewhere to earn some additional return. In Mohit’s case, a concessional loan reduces the cost further, so keeping it won’t harm him financially even after retirement.

Emotional comfort comes from not having a loan or liability. Even those who have a stable job and regular income are sometimes not ready to take on a loan. Having a loan means any risk to income in the future will reduce the ability to repay. To earn that emotional freedom, many ignore the financial logic, and prefer to prepay their loan. If the loan is for a house, the emotional need to own it without liability is strong. No one thinks of selling the house to repay a loan, as it brings severe emotional stress. Being close to retirement, Mohit sees his income reducing in the future and may not like having an outstanding loan.

On the other hand, using the retirement corpus to repay the loan might reduce the money available to generate post-retirement income. The decision Mohit takes will depend on how he sees this trade-off. If he makes the calculation by comparing the return on his investment with the interest rate of the loan, he may find that investment return is higher than his concessional interest cost. In an emergency, the investment corpus can be used to repay the loan, without selling the house. Hence, Mohit should keep the home loan unless his emotional need to repay is too high.

Content on this page is courtesy Centre for Investment Education and Learning (CIEL).
Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.