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Should you pre-pay your home loan in a rising interest rate scenario?


Should you pre-pay your home loan in a rising interest rate scenario?

Interest rates are steadily being increased by several financial institutions with many others expected to follow suit in the near future. In this scenario, should you be pre-paying your home loan? SBI has already scaled up its MCLR by 5 basis points across various tenors. Every loan comes with a reset clause which is the period post which the prevailing rate of interest can be changed. SBI presently offers home loans up to RS. 30 lakh at an MCLR of 8.70%-9% annually. This is the same story with several other banks and financial institutions.

However, before you finalize pre-payment for your home loan, you should take a moment to consider the probable tax benefits that you will be eligible for, upon repaying the interest and principal amount each year. Deductions up to Rs. 1.5 lakh annually are allowed on the principal repayment under Section 80C with deductions allowed up to Rs. 2 lakh for interest repayments under Section 24 (B). While deductions under Section 80C also include other things like insurance policies, EPF, tuition fees for children and investments made in equity-linked savings schemes, the deductions under Section 24 are solely for home loans.

As per estimates, for an interest rate of 9% on your home loan, the tax benefit will come to approximately 6.2% in case one falls in the highest 31.2% tax bracket. The effective rate of interest will be higher for those in lower tax slabs. Experts advise that you should not have a home loan running if you have the ability to foreclose it. The tax savings only happen when you pay the interest rate which in itself may amount to a considerable sum. However, if you cannot maintain EMI repayments and wish to invest the surplus funds in equity funds, you can go for a combination of these two aspects. Pre-pay some amount of the home loan and invest the rest.

In case you invest the added funds for long-term wish fulfillment via equity funds which can give you returns of around 12% over the long haul, compare it with interest rates of 8.5-9%. Home loans are only advantageous in case you get a better return from investments in direct equity/equity funds for a long period of time. Partial pre-payments also lighten the burden without leaving you bereft of any tax benefits.

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