Transfer Money to Overdraft Account vs Invest in EPF/PPF?

You have a home loan with an overdraft facility (such as SBI Maxgain). Where would you send your excess money? Transfer to your overdraft account or to your EPF/PPF account? Let us find out.

The Benefits of Overdraft Account

By putting money in the overdraft account, you save on interest. And interest saved is interest earned. So, if the loan interest rate is 8% and you put Rs 1 lac in the overdraft account, you will pay Rs 8,000 less interest on the loan over the next 12 months.

An overdraft account serves multiple purposes. It reduces the interest that you pay on the loan. And you can expect the home loan interest rate to be higher than most safe fixed income products. Moreover, you retain flexibility with your money. You can take out money for any requirement. For this reason, many investors keep their contingency funds in the home loan overdraft accounts.

By keeping money in OD account, you save on home loan interest and still retain flexibility with the money. You could have saved on interest payment by making a loan prepayment too.  However, once you have used the money to prepay the loan, you cannot access it. You lose flexibility with the money.

What about EPF and PPF?

While the home loan interest rate is likely to be higher than most safe fixed income product, EPF and PPF are different. While the returns that PPF and EPF offer can change, the tax-fee interest in these products is attractive for the fixed income portion of the long-term portfolio.

PPF currently offers 7.1% p.a. EPF offered 8.5% in the FY2021.

Moreover, you need to compare the post-tax cost of loan with the post-tax return from EPF account. If the post-tax cost of loan is higher, you should route incremental funds to the Overdraft account. However, the post-tax cost of loan can vary across investors. It depends on your marginal tax rate. For a borrower in the 5% tax bracket, the post-tax cost of an 8% p.a. loan is 7.6% p.a. For a borrower in the 30% tax bracket, the post-tax cost of loan is only 5.6% p.a.

It depends on the loan amount too. The benefit for interest payment under a housing loan under Section 24 is capped at Rs 2 lacs per annum for a self-occupied property. Thus, if you have a loan of Rs 80 lacs, the entire interest payment during the year will not be eligible for the tax-benefit. That keeps your post-tax cost of loan high. Moreover, any contribution you make to your overdraft account comes from your post-tax money.

You get tax benefit on contribution to EPF account (both your contribution and the employer contribution) and PPF accounts. Contribution to EPF and PPF accounts qualify for tax benefit under Section 80C (maximum 1.5 lacs). Employer contribution to EPF up to Rs 7.5 lacs per annum qualifies for tax benefit. So, at least some portion of this money may be coming from your pre-tax money.

To summarize, you have a choice of putting Rs 100 in PPF/EPF account or Rs 70 in the overdraft account. Note that I have assumed Rs 100 comes from pre-tax money. That may not always be the case.

Over and above, you need to compare the post-tax cost of loan against the return you earn on EPF account. My sense is that post-tax cost of loan will struggle to beat post-tax return on PPF/EPF, especially for those in the highest income tax bracket. To be honest, this post is likely relevant only for such high-income investors.

Therefore, for a completely rationale person, EPF/PPF contribution might be a better choice.

Points to Note

EPF is a retirement product. Thus, it is fair to expect that you would not need to access your EPF soon. You cannot put money in EPF for the short-term use. Overdraft account is a better option if you need the money in the short term.

You cannot put unlimited amounts in home loan overdraft account. Any excess in the OD over the principal outstanding will not result in any interest-savings. Moreover, the principal outstanding goes down with time. This caps the amount of money you can keep in overdraft account and this cap goes down with time.

You cannot put unlimited amounts in EPF either. There is limit to tax-free employer contribution. There is an annual limit (of tax-free interest) of Rs 2.5 lacs on your contribution too. Interest on contribution above Rs 2.5 lacs is taxable. So, you cannot just wake up one fine day and decide to route loads of money into EPF every month by way of voluntary contributions. You need to pace your EPF contributions accordingly.

Moreover, with EPF, you cannot change your contribution every month. Most employers will not allow that. The employers allow a window (usually at the beginning of the financial year) to specify your choice. Thus, if you want to contribute more to your EPF account, you need to plan.

Similarly, there is limit of Rs 1.5 lacs per annum for contribution to PPF account. You need to pace your investments in PPF too.

What Should You Do?

I have tried to make this analysis very rational, which is not always how most of us think. And that makes sense too.

As with prepay or invest decision, you can continue to route money to your OD account until the net loan amount (principal outstanding – OD account balance) becomes comfortable. “Comfortable” is subjective. For instance, Borrower A and B have taken home loan of Rs 1 crore. A may feel comfortable when the net loan amount is 50 lacs, while B may be comfortable if the net loan amount is 30 lacs.

Once you feel that your loan position is comfortable, you can compare the post-tax cost of loan against post-tax return from PPF and EPF and make a rationale choice.

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