Should you prepay your home loan or invest the surplus funds in other asset classes? Well, deciding whether to close a home loan or not is always a tough decision.
“Home loan is one of the biggest liabilities for most of the people with repayment period spanning up to 30 years. However, most borrowers prefer to get their house debt-free as soon as possible. As the interest rate has come down to the lowest level seen in a decade, it presents a wonderful opportunity to give maximum acceleration to your home loan repayment. If the borrower has excess funds and can repay the loan, then a low-interest rate scenario is a great time to make partial prepayment as it would accelerate the overall repayment and reduce the outstanding tenure significantly,” explains Amit Goenka, MD and CEO at Nisus Finance.
Let’s delve deeper.
Reasons for prepayment
There are usually two reasons for prepayment:
- The borrower may have arranged the required finances, or
- The borrower wants to opt for refinancing to avail lower interest rates
Prepayment charges
In 2013, the Reserve Bank of India waived off the prepayment charges on floating rate loans. Thus, if you are on floating interest rates, you don’t have to pay any charges. However, this rule is not applicable if you are on a fixed rate.
However, it is good to talk to your lender before prepaying your home loan to understand the nuances of pre-closure.
How to decide?
Explaining the same, Vaibhav Sankla, Principal, Billion BaseCamp says, “If the interest rate on housing loan is 7% and you have surplus funds, in most cases, you would be better off with investing your funds than repaying the loan. You can opt to invest in REITs or InvITs, which offer a steady income with some growth opportunities at relatively lower risk. Plus non-repayment would also mean that you would have extra liquidity in these uncertain times.”
Analyse your finances
First and foremost, take stock of your finances. It is not ideal to use up all your savings to prepay the home loan. Make sure you have enough savings to run your household comfortably. Now, you must be wondering how much is enough? Before the pandemic, experts used to suggest a contingency fund for at least six months. However, these days, some suggest maintaining a contingency fund to cover expenses for 12 months.
Also, try to figure out if you are likely to have any significant expenditure in the coming months. It could be the education needs of your children or buying a vehicle, etc. In such scenarios, it is ideal to keep the surplus with you to avoid financial troubles later. It is worth mentioning here that the interest rates for a home loan are comparatively lower than a personal or gold loan.
Tax benefits
You will lose out on tax benefits available on a home loan. Currently, Section 80C of the Income Tax Act allows for deduction against principal payment of the home loan up to a threshold of Rs 1,50,000. And interest paid against the home loan is allowed as a deduction under Sec 24B up to a limit of Rs 2,00,000.
However, “the tax benefit is limited to Rs 2 Lakh of interest payment in a given financial year. So, if you are paying a much higher interest amount, especially with a loan amount of Rs 30 Lakh and above, then you would not get any tax benefit on additional interest amount,” adds Amit.
In such a scenario, it would make sense for you to make partial prepayments to bring down the outstanding to a level where you can optimise your tax benefits. Thus, one must evaluate the impact of prepayment on your overall tax liability.
Different ways to prepay a home loan
There are two ways by which you can go for prepayments. The first approach is by increasing your EMI amount. As the income rises, many borrowers can afford higher EMIs. EMI increase can be opted for if you want to reduce the overall tenure of your loan. So, if you are in that boat, you can deleverage yourself in the long-term by running down your loans faster.
Another way is making bulk payments every year.
Ideal time for prepayment
Let’s look at two factors to understand this:
Interest rates: According to financial experts, it is ideal to prepay when the interest rates are lower. This is because when interest rates are low, a higher amount gets diverted to repaying your principal.
Age: For those closer to retirement, it is better to finish all liabilities.
Some points to remember
- Don’t forget to read the terms and conditions before you prepay the amount.
- Avoid burning all your savings to repay the loan. It may add to the financial stress and may impact your lifestyle.
- Keep a track of your bank statements that reflect your EMIs.
- Always avoid hasty decisions.