Home loan is one of the biggest liabilities for majority of the people who buy houses. Most of them stretch their eligibility for getting the highest possible loan amount and hence the repayment period becomes quite long spanning over 15-20 years. However, most borrowers prefer to get their house debt-free as soon as possible.
Partial prepayment is a good way to bring down the loan outstanding sequentially. Since most of the home loans are on floating rate of interest therefore there is no penalty for partial prepayments. EMI of your loan consists of two parts -- interest amount and principal repayment. When interest rate comes down and EMI remains unchanged then the interest part decreases and principal part of EMI increases. Therefore, low interest rate accelerates your repayments. On top of it, if you can make more payments towards principal then home loan outstanding will come down at much higher speed.
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 low interest rate scenario is a great time to make partial prepayment as it would accelerate the overall repayment and reduces the outstanding tenure significantly," says Aarti Khanna, Founder and CEO, AskCred.
How long the low interest rate will last?
Given the economic slowdown due to coronavirus pandemic, interest rates are unlikely to see any hike. On the contrary, chances of further rate cut cannot be ruled out. "Once we see recovery on the major aspects of the economy, which may take up to the end of this fiscal year, we might see some balancing of the interest rates, in order to prevent excess monetary supply and inflation build-up," Kunal Varma, CBO and Co-founder, MoneyTap says.
Any significant increase in interest rate looks at least a year away. "There are too many factors at play and it's always difficult to predict, but one can reasonably expect rates to remain low till at least the end of this year if there are no more external shocks or surprises," says Varma. This low interest period presents wonderful opportunity to bring down your loan outstanding as much as possible.
How to use partial prepayment
If you can afford there are two ways by which you can go for prepayments. First approach is by increasing your EMI. With time 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 since you have increased monthly payment capacity and you're sure of your income, but you don't have a lot of savings yet. So if you're in that boat, then you can deleverage yourself in the long-term by running down your loans faster," says Varma of MoneyTap.
When you go for EMI increase bank will take time to process your request. "The bank would re-ascertain the current debt burden of the borrower and increase the EMI on the basis of the current eligibility," says Khanna of AskCred.
The second way is by doing bulk prepayments. There are many bulk payments that you may receive occasionally or periodically that you can utilise towards partial prepayments like bonus, incentives, arrears and rewards. "Alternatively if the borrower has received a lumpsum amount like a bonus/ reward etc then the borrower can choose to make a bulk partial prepayment and even opt for reducing the loan tenor along with it," says Khanna.
Unpredictable income - Use Home Saver option
Many people with unpredictable income flows may prefer an option which gives them maximum flexibility to use repayment with flexibility to access funds later on if needed. "A Home Saver loan allows the borrower to reserve the extra amount in the home loan account and he/she can withdraw it anytime as the need may arise. While calculating interest the bank computes the same by deducting the balance in the current account from the borrower's outstanding principal. The money thus kept in the home loan account reduces the total interest outflow on your home loan and gives the borrower the flexibility to maintain the liquidity as well at the same time," says Khanna.
If you have unpredictable income then you may go for this option or get your loan transferred to a lender that offers this option.
When prepayment is most desirable
Home loan is a good tool to save taxes both on account of interest and principal repayment amount. So continuing a loan may bring substantial tax-saving to people especially in higher income tax bracket. 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.
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. "In high ticket loans like a home loan, if the borrower consistently makes part prepayment during a low interest period he can benefit by saving some considerable amount," says Khanna of AskCred.
When not to go for prepayments
If your home loan amount is lesser and you prefer tax-saving then prepayment may not be the right option for you. "Investors in the 30 per cent tax bracket, and whose outstanding home loan balance is less than Rs 20 lakh and the annual interest outflow may fall below the Rs 2 lakh deductible limit may find good tax free investment options in the market and hence prepayment in such a scenario may not be a good option," says Khanna.
In cases where both the spouses are enjoying tax benefits separately the loan amount that can be continued will be bigger. "If the loan is taken jointly with a co-applicant, for example, spouse and both share the EMI burden then the interest deduction benefit can be claimed by each of them for an amount of Rs 2 lakh each. In such a scenario there is no need to prepay if the outstanding amount is less than Rs 40 lakh," says Khanna.
Invest or prepay?
Home loan comes at the lowest interest rate and on top of it, there is tax benefit. When best home loan rate is available around 7 per cent the effective rate of interest of home loan for people in highest income tax bracket comes out to be less than 5 per cent. Many people can generate higher return than this by investing the surpluses. So, does it make sense for you to invest your money for higher return than making prepayments?
"If income and cash flows are not under stress, then there need not be any rush to prepay loans and let go of the surplus liquidity unless the rate of interest you're paying is unusually high. If you can invest that surplus liquidity in something good, then you're better off doing that and not worrying about loan repayments at the same time," Varma of MoneyTap. If you have risk appetite and have confidence that you can generate higher returns by investing in high return investment like equities for a long-term period than investing could give you better results.
However, there are many people who prefer peace of mind by being debt frees as soon as possible. "Home loans are loans with a longer tenor commitment of 10-15 years and several unfortunate happenings like job loss, prolonged illness etc can happen anytime during this long period. Hence prepaying the loan would be the best and wise option," says Khanna of AskCred.
