Home loan prepayment is an important decision that borrowers have to take during their working lives. There could be a variety of reasons for this decision. You may have earned a good appreciation on your equity investments and you feel that the money is big enough to repay your outstanding home loan. Secondly, you could have sold off a piece of land or property in your ancestral village and you are wondering how to put your money to good use. It is also likely that you expect home loan rates to go up with rise in interest rates and want to protect yourself against that. All these could be home loan prepayment triggers for you. The question is how to prepay your home loan smart way? Are there any home loan prepayment tips that borrowers need to consider?
Before you take the decision to prepay the home loan, there are 2 important points you need to understand. Your home loan gives you tax benefits in the form of Section 24 for interest component and Section 80C for the principal component. When you prepay the home loan you lose both these benefits. Secondly, and more importantly, every bank will have its set of rules for prepaying your home loan. But you are perfectly in a position to negotiate on items like prepayment charges and other costs involved. Make the best of it!
5 factors to consider before prepaying your home loan..
Before you take your prepayment decision, there are some key questions you need to ask yourself. That is what will drive your home loan prepayment decision..
How many years of the home loan tenure have I completed?
This is one of the primary considerations. Your home loan repayment schedule is structured in such a way that in the initial years you pay more of the interest component whereas in the later years you pay more of the principal component. For example if you are having a 20 year loan then it would make sense to repay the loan within the first 10 years. If you try to repay after the 15th year then you will not really save on interest as most of the interest cost has been borne by you. In the last few years, a large chunk of your EMI is accounted for by the principal component. When there is no interest saving, you can put that lump-sum money to better use.
Provide for the loss of tax benefits and compare with cash flow benefits
These are two very important considerations when you decide on your home loan prepayment. Firstly, you will lose out the benefit of Section 24 for interest and Section 80C for the principal component. Both of them are 30% rebates and hence they will make a big difference to your tax outflows. While Section 80C can be substituted with other assets, there is no alternative for Section 24. Also, look at whether you need the additional cash flows that you save from prepaying the home loan. The caveat is that if you have two home loans then it procedurally makes sense to prepay one home loan.
Do you have a more high yielding asset to invest in; then avoid prepaying
Any financial action is an opportunity cost assessment and so is the decision to prepay your home loan! The interest rate on a home loan is 9% and if you consider the 30% tax rebate under Section 24 then the cost is approximately 6.3%. If you can invest you money in assets that yield more than 6.3% in post-tax terms, you are certainly better off. With equity funds and balanced funds yielding well above 12% annualized in post-tax terms, prepaying a home loan may not be a great option.
Will this prepayment impair your other cash flows for your long term goals
Every person has long term goals in the form of retirement planning, planning for their child’s education, planning for their child’s wedding etc. All these goals entail large outlays in financial terms. If the prepayment of your home loan is going to negatively impact any of your goals, then it is better you set aside your lump-sum amount for that bigger purpose.
Prepayment charges and other penalties..
The NHB has barred home loan companies from charging prepayment charges but most of them only exempt partial prepayment from exit loads. Otherwise your prepayment penalties can be as high as 3-4% on the outstanding principal, which can work out to be a huge sum for the borrower. Consider this point too as it impacts your net cash position.
How to payoff home loans faster in India..
So what is the final decision? Should you or should you not prepay your home loan if you have a lump-sum available with you? While the above factors are the key to your decision, there are 2 cases where prepayment makes economic and administrative sense to you. Firstly, if you have two homes and two home loans, then it is a good idea to close one of them when you have liquidity on hand. That leaves you with the tax benefits and also better cash flows in the process. Secondly, if are expecting a sharp spike in interest rates and you are having a floating rate loan, then it makes sense to prepay the loan. Of course, try to prepay the loan when the interesting outstanding is still high. That is when the savings from prepayment will actually accrue to you.