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Is It Always Beneficial To Prepay Your Loan?
Previously we have discussed how prepaying loans can be an option when interest rates are on the rise. But is it always beneficial? Let's see:
There are some investors who once they have taken a loan, prefer to prepay it as soon as possible because the idea of being ‘in debt’ is not comfortable for them.
This is a personal matter and while there is no question that these investors genuinely feel uncomfortable about the loan It is not always necessary that prepaying make financial sense. The simple reason for that is the opportunity cost of your money.
For example, if you have a loan which is charging you interest at 10% p.a., and you suddenly come into some surplus funds.
You know that you can either use these funds to prepay full or part of your loan, or to invest. The first thing you should do is check the opportunity cost of these surplus funds.
Would it make more sense to prepay the 10% interest loan, and thereby save yourself from paying the 10% interest?
Or would it make more sense to invest the funds into an investment product that can generate more than 10% return - based on your risk appetite and time horizon?
If there is an investment instrument which would give you a long term rate of return that is higher than the rate of interest you are paying on your loan, it makes financial sense to invest the funds and earn the higher rate of return, than to prepay the loan (in full or in part) and save yourself the lower rate of interest.