Is it always best to repay all loans before retirement?
Posted by: Arti Bhargava on Feb 12, 2018, 06.30 AM IST
Ashish will retire in five years. He owns a property bought with a home loan from a bank. He gets a concessional rate by virtue of being an employee, and is in no hurry to prepay the loan. When he retires, he wants to live off his pension, rental income and some investment returns. He is not sure if he should prepay the loan before retirement and be debt free, or allow the loan to continue until he is 65.
If the value of the home is growing at a rate that is higher than that of the loan, it is fine to keep the loan. In Ashish’s case, a concessional loan reduces costs further, so keeping it wouldn’t harm him, even after retirement.
However, emotional comfort comes from not having a loan or liability. Even those who have a firm job and regular income are sometimes not ready to take on a loan. A loan may sound like risk to some. For the sake of mental peace, they ignore 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 off a house to repay a loan, as such an action brings severe emotional stress. Ashish, being close to retirement may not like the risk of having an outstanding loan.
The decision Ashish takes will depend on how he sees the trade-off. He has the option to earn a rental income and augment his post-retirement income. Or he will have to be content with less cash post retirement, since he will be drawing upon his corpus to repay the loan. If Ashish compared the return on his investment and the interest rate of the loan,
he may find that the investment return is higher than his interest cost. In an emergency, his corpus can be used to repay the loan, without selling the house. Ashish should keep the loan unless his emotional need to repay is too high.
(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)