Q1. I’m a 32 yo product designer. I took a loan of 10 lakh to buy a car 2 years back and I paid 20,000 EMI every month for 5 years. I got a bonus of 2 lakh last month. Should I use it to pay off the loan or invest it instead?
-Suraj Jaiswal, Jaipur
There are various factors that go into this decision, but the most important one is your state of mind. Loans are a liability that can come in the way of your goals if not planned well. For example, if you are someone who hates their job, you might feel held back because of the loan. In that case, we’d advise you to pay it off sooner.
READ MORE: Ever wondered how your insurance company decides on your car premiums?
Now, coming to more technical terms. Here are a few things you should definitely check:
1. The difference in interest rate vs the returns of investment.
A loan has two important components- the principal component and the interest component. The way it is structured in your EMIs is very important.
Your Initial EMIs go towards interest, and as your loan gets older, the EMIs go towards the principal. So the older the loan gets the principal amount increases because of the cumulative interest.
So the first thing you should do is, compare the rate of interest you might get by making a lump sum investment and the interest on the loan you might save by paying off the loan.
2. The second thing to consider is the point of the loan tenure you are doing this.
If it’s happening at a very early stage in your loan tenure, say within a year, we’d say just pay it off. But if it’s at a much later stage, do the math first.
a. How old is the loan? and how much is outstanding?
Considering the loan is 2 yo and EMI is Rs.20000, the outstanding loan amount might be somewhere around 667735.
b. Check the Interest payout. How much interest amount is left?
Remember that if the return on lumpsum investment is more than pro-rata interest on the loan, you are better off investing it. In your case, the outstanding interest is around 88652. Now define how much return you can expect by investing and compare the two.
In your case, the interest on the loan is 8% for the remaining years. Say you invest the lumpsum in a certain mutual fund whose average annual return is known to be around 10%, then, investing might make more sense.
Disclaimer: The information or numbers presented herein are contextual and not to be taken literally. See the appendix to understand how we derived the numbers.
Q2. I’m the father of 5 yo twin daughters and a commercial artist by profession. I’m trying to secure education funds for my daughters, however, I don’t exactly have the knowledge or appetite for equity investments. What is better PPF or Sukanya Samriddhi Yojana? Can I avail it for both daughters or is there a limit?
Suyash Kadu, Nashik
Yes, two accounts cannot be opened up for two girls. Sukanya Samridhhi Yojana and PPF schemes are quite similar except for a few withdrawal rules and a nominal difference in interest.
Sukanya Samriddhi Account provides an interest rate of 7.6% pa whereas PPF provides 7.1% interest. However, the former is only available for parents of a girl child as its objective is the welfare of a girl child.
READ MORE: How to build a bright future for your daughter with Sukanya Samriddhi Yojana
Both are fixed-income deposits backed by the government and are among the safest investment options. Both provide substantial and guaranteed returns along with tax benefits. Both SSY & PPF can be opened in your nearest bank or post office. Let’s look at the specifics for further comparison:
Deposit limit
The max you can invest in both schemes is 1,50,000 whereas the minimum you require to invest in PPF is Rs, 500, and in the case of SSY, it's Rs.250.
Interest rates
The interest rates are revised and declared quarterly for both schemes. For example, SSY used to offer 9.10% in April 2014 which has now come to 7.6% in Q1 of FY 22-23. The same goes for PPF, the scheme used to offer 12% interest at some point, which has now come down to 7%. These interest rates still stand higher than regular saving deposits like FD & RD.
Tax Benefits
Investments in PPF & SSY both are eligible for exemptions under Section 80 C. The interest received is tax-free and upon maturity, you will be able to withdraw the amount tax-free.
Withdrawal rules
Here is how both investments differ. In case of PPF, you can withdraw the amount after 15 years or even make partial withdrawals after the completion of the 6th year. You can also extend the scheme and continue to earn interest on the corpus without further deposits.
When it comes to SSY, the lock-in period is 21 years, However, deposits are only made for 15 years. In your case, if you open an SSY for your daughters now, they will be able to withdraw it when they turn 26. However, partial withdrawals (50% are allowed for two reasons- education and marriage, provided the daughter has reached 18 years of age.
Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.
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