Prepayment versus SIP: how to compare them

Why the simple comparison is wrong

A prepayment gives you a certain, immediate, risk-free return equal to your loan rate. A SIP gives you an uncertain return, realised over an unknown period, taxed on exit. Before you can set them side by side, both numbers have to be adjusted.

Step 1: find your effective loan rate after tax

Home-loan interest is deductible up to ₹2,00,000 a year under Section 24(b) for a self-occupied property, but only under the old tax regime. Under the new regime there is no such deduction for a self-occupied home.

• New regime, no deduction: your effective cost is the full rate. At 8.5%, prepaying earns you a guaranteed 8.5%.
• Old regime, and you are below the ₹2 lakh cap in the 30% bracket: your effective cost is roughly 8.5% × (1 − 0.30) ≈ 5.95%.
• Old regime, but your interest already exceeds ₹2 lakh: any interest above the cap is not deductible, so the marginal rupee you prepay saves the full 8.5%. This is the case for most large loans in their early years.

That last point matters. On a ₹50 lakh loan at 8.5%, first-year interest is over ₹4 lakh — more than double the cap. The deduction is already maxed out, so the prepayment comparison is against the full rate.

Step 2: find your effective SIP return after tax

Long-term capital gains on equity funds are taxed at 12.5% above the annual exemption of ₹1.25 lakh; gains realised within a year are taxed at 20%. A nominal 12% return therefore lands closer to 10.5% after tax on a long hold — and that 12% is itself an assumption, not a promise. Indian equity has delivered long stretches of 5% and long stretches of 18%.

Step 3: price the risk you are taking

Prepayment has zero volatility. To prefer the SIP you need the equity premium — the extra return over the guaranteed alternative — to be worth the chance of a 30% drawdown arriving in the same year your income does not. A 2% after-tax edge is thin payment for that risk. A 6% edge is not.

How the answer usually falls

• Loan rate above ~9.5%, or no tax deduction: prepay. Few risk-adjusted portfolios reliably beat a guaranteed 9.5%.
• Loan rate around 8% to 8.5% with a full deduction, long horizon, stable income: the SIP has a real edge — but only if you actually stay invested through a crash.
• Job insecurity, single income, or near retirement: prepay. Removing a fixed obligation is worth more than an expected return.
• No emergency fund yet: neither. Build six months of expenses first. Money put into a loan is very hard to get back out.

The split most people should take

This is not a binary. A common and sensible arrangement is to prepay enough to close the loan a few years early — say ₹5,000 a month — and invest the rest. You get a large, certain reduction in your debt horizon and keep meaningful exposure to equity. The psychological value of a shrinking tenure is real, and it is what keeps people consistent.

Run your own numbers

Use the calculator to see exactly what your monthly amount saves in interest and years. Then compare that rupee figure against the same monthly amount compounded at your honest after-tax return assumption over the same period — not over thirty years, over the period until the loan would have closed.

This is general information, not financial advice. Your tax position is specific to you; check it with a qualified professional.