Should you prepay your home loan? Experts explain the pros and cons
PremiumPrepaying a home loan is the best thing that a borrower can do. Although there are contrasting views on this as well
Buying a house is not only ones biggest dream in our lifetime but is also undoubtedly the significant financial task of our lifetimes. One of the most innovative ways to save money is to prepay your home loan early. You may prepay the entire outstanding home loan amount or prepay partially to save on home loan interest payments. Prepaying a home loan is the best thing that a borrower can do. Although there are contrasting views on this as well.
Is it good to prepay your home loan?
Archit Gupta, Founder & CEO, Clear said that the home loan interest component is higher during the initial years but keeps coming down towards the end of the home loan tenure.
If you prepay your home loan, the amount goes towards repaying your home loan principal amount. The following month’s interest would be calculated on the outstanding home loan principal amount. If you prepay the home loan, you can substantially reduce the interest component of the home loan. The principal amount gets repaid faster, helping you close the home loan early.
Gaurav Kapoor, Director & Co-Founder, Fincorpit Consulting explains that the interest will only be calculated on the amount remaining after your prepayment is applied to your outstanding principal. As a result, you will significantly reduce the interest component and the principal will be repaid faster for the remaining term of the loan.
“In contrast, if you take out a floating rate loan, you cannot be charged for prepayment. Take note, however, that if you have opted for a fixed-rate loan there may be a prepayment fee. One, lower interest part and two, higher principal part - in the following EMI. They could assist you to lower the interest substantially, towards the remaining tenure of the loan and the principal getting repaid at a quicker pace," said Gaurav Kapoor
He added that as a result of your prepayment, you finish up your loan much before, you thought at the start. Hence, prepayments would be an effective thing the customers might not know or might not think for choosing these. Regularized micro prepayments get auto-debited from your bank account, hence this is the best option.
Should you prepay your home loan?
You may consider prepaying your home loan, depending on your financial condition. For instance, you could prepay your home loan if you get a windfall or a bonus. Moreover, banks and NBFCs do not charge you a prepayment penalty on the prepayment of floating rate home loans.
“If you have a large quantum of a home loan or the bank is charging you a higher home loan rate, then it may be a good idea to prepay your home loan. However, you may continue with the home loan if the bank charges you a lower home loan rate and you avail of significant tax benefits on home loan principal and interest," said Archit Gupta.
Home loan repayment: Factors to keep in mind
Prepaying a home loan can be quite tempting considering the lack of monthly EMI payments & the possibility of being debt free. However, there are certain factors one should evaluate while making this big decision. Pratik Daudkhane, Co-Founder at Decentro says there's no one-size fits all solution to this problem.
Source of funds to repay the home loan
If you're thinking of partly exhausting your emergency corpus, I recommend against it, said Pratik Daudkhane.
Bonus
If you've received a bonus, you may evaluate the returns in the capital markets instead of prepaying. If the returns are higher than the interest rate, the market returns will service the cost of interest, and hence, you would have more disposable income from your fixed income (e.g., salary). However, investing in capital markets can be risky and higher returns cannot be guaranteed.
Savings
In some cases, the interest rate of the home loan is higher in the initial tenure. If your savings allow you to set aside a small amount every month or year, you can save significantly on interest expenses during the tenure of the loan.
Working of the prepayments
Suppose a loan of ₹20 lakh has been taken by you for a tenure of 20 years at a 7.5% rate of interest. While your monthly EMI, is ₹16,111. You end up paying ₹38.7 lakh at the finish of 20 years, directed that your interest cost comes to around ₹18.7 lakh on a loan of ₹20 lakh. If we see this example it is a lot of money for the payer basically double the amount taken.
Suppose you avail of a home loan of ₹25 Lakh for a 20-year tenure at an interest rate of 8%. Your home loan EMI comes to ₹20,911. Prepaying a lump sum of ₹5 Lakh after 12 months saves interest of over ₹12 Lakh.
Pros of prepaying home loan
-You could prepay your home loan if you are close to retirement to eliminate liabilities and enjoy a peaceful retirement.
-As banks charge higher interest rates for home loans than what you may earn on most financial instruments it could make sense to prepay home loan and save on interest rather than invest in fixed income instruments which offer lower returns.
Cons of prepaying home loan
-You qualify for a tax deduction up to ₹2 Lakh per annum on home loan interest repayments. It helps you reduce taxes by around ₹40,000 and 60,000 per annum if you are in the higher income tax brackets of 20% and 30%. You may lose this tax benefit if you prepay the home loan.
-Do not prepay home loans with the money you have invested for vital financial goals.
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