Are you considering whether to pre-close your car loan or invest extra savings? Deciding between pre-closing a loan and investing extra savings can be a complex financial decision. With interest rates, prepayment charges, and potential investment returns to consider, it’s important to analyze all factors to make an informed choice. This article aims to provide a detailed comparison to help you determine the best course of action.
For this analysis, we will use a hypothetical scenario based on the following details:
Initial Loan Amount: ₹9,92,500
Outstanding Principal: ₹5,57,108
Interest Rate on Loan: 7.4% per annum
Remaining Tenure: 31 months
Total Loan Period: 5 years (60 months)
Prepayment Charges: 3.54% on the outstanding principal
Total Amount for Pre-Closure: ₹5,78,776.62
We will also assume different savings rates and periods to see how these variations impact the decision-making process. By the end of this article, you will have a clear understanding of the financial implications of pre-closing your loan versus investing your extra savings.
Current Financial Details:
Initial Loan Amount: ₹9,92,500
Outstanding Principal: ₹5,57,108
Interest for the Month: ₹1,947
Prepayment Charges (3.54% on Outstanding Principal): ₹19,721.62
Total Amount for Pre-Closure: ₹5,78,776.62
Interest Rate on Loan: 7.4% per annum
Remaining Tenure: 31 months
Plan:
Accumulate Extra Savings for a Variable Period and Pre-Close the Loan
Invest the Extra Savings
1. Accumulate Extra Savings for a Variable Period and Pre-Close the Loan
If you accumulate extra savings for a variable period, you need to calculate whether you can cover the total amount required for pre-closure (₹5,78,776.62).
Scenario Analysis
Assume you save different amounts each month for varying periods:
Scenario A: Saving ₹80,000 per month for 7 months
- Total Savings: ₹80,000 * 7 = ₹5,60,000
Scenario B: Saving ₹50,000 per month for 10 months
- Total Savings: ₹50,000 * 10 = ₹5,00,000
Scenario C: Saving ₹1,00,000 per month for 5 months
- Total Savings: ₹1,00,000 * 5 = ₹5,00,000
In each scenario, compare the savings to the amount required for pre-closure (₹5,78,776.62). You may need to save for additional months or use existing savings to cover the shortfall.
Steps to Pre-Close the Loan:
Accumulate the required savings over your chosen period.
Pay the accumulated amount along with any additional amount needed for pre-closure.
Interest Savings from Pre-Closure:
Interest saved over the remaining tenure (24 months) can be calculated as follows:
Monthly Interest = Principal * Monthly Interest Rate
Monthly Interest Rate = Annual Interest Rate / 12
Total Interest Saved = Monthly Interest * Number of Remaining Months
Using the numbers:
Monthly Interest Rate = 7.4% / 12 = 0.6167%
Total Interest Saved = ₹5,57,108 x 0.006167 x 24 ≈ ₹82,253
2. Investing the Extra Savings
If you invest the extra savings each month, the returns will depend on the investment rate. Assume an annual return of 8% for the investment (you can adjust the returns as per your preference, but it's important to choose a logical figure within a specific time frame).
Future Value Calculation for Different Scenarios:
Scenario A: Saving ₹80,000 per month for 7 months
Future Value can be calculated using the future value of a series formula.
Future Value ≈ ₹80,000 * (1 + 0.00667)^7 ≈ ₹5,73,440
Scenario B: Saving ₹50,000 per month for 10 months
- Future Value ≈ ₹50,000 * (1 + 0.00667)^10 ≈ ₹5,17,000
Scenario C: Saving ₹1,00,000 per month for 5 months
- Future Value ≈ ₹1,00,000 * (1 + 0.00667)^5 ≈ ₹5,20,000
Comparative Analysis:
Interest Saved by Pre-Closure: ≈ ₹82,253
Pre-Closure Charges: ₹19,721.62
Net Savings from Pre-Closure: ₹82,253 - ₹19,721.62 = ₹62,531.38
Investment Gains for Different Scenarios:
Scenario A (₹80,000 for 7 months):₹13,440 (Total Value: ₹5,73,440)
Scenario B (₹50,000 for 10 months):₹17,000 (Total Value: ₹5,17,000)
Scenario C (₹1,00,000 for 5 months):₹20,000 (Total Value: ₹5,20,000)
Decision Making:
Prepaying the Loan:
Interest Savings:₹62,531.38 net.
Total Amount for Pre-Closure: ₹5,78,776.62.
Loan completely paid off sooner.
Peace of mind from being debt-free.
Investing the Extra Savings:
Potential Gains:₹13,440 to ₹20,000 depending on the scenario.
Risk associated with investments, especially in volatile markets.
Maintain liquidity and flexibility with funds.
Recommendation:
Given the substantial net savings from pre-closure (₹62,531.38) compared to the potential investment gains (₹13,440 to ₹20,000), pre-closing the loan after accumulating the extra funds for the necessary period is generally more financially beneficial. This approach ensures complete debt elimination and significant interest savings without the associated risks of investments.
However, if you prefer to keep your funds invested and are comfortable with the risks, investing the extra savings could still be a viable option. Consulting with a financial advisor for personalized insights is always recommended to align this decision with your overall financial goals and risk tolerance.
Conclusion:
Both pre-closing the loan and investing the extra savings have their merits. The key factors to consider are the guaranteed interest savings and debt-free peace of mind from pre-closing the loan versus the potential (though uncertain) higher returns from investing. Assess your risk tolerance, financial goals, and preferences to make the best decision for your situation.