Home loans are definitely a boon and a burden at the same time. While this sounds like an oxymoron, the feeling is certainly something that many of us will testify to. While home loans are what enable us to finally purchase our dream homes, they also make for huge financial commitments that necessitate discipline and repayment for longer durations. Now, while you may be thinking that you’ve fallen into a comfortable zone in terms of your finances and can easily repay the home loan EMI, you should plan ahead.
Interest costs are what you should look to shave off for obvious reasons. The more you save on interest costs, the cheaper your home loan becomes and the lesser it eats into your earned income over the years. In this context, prepaying your home loan periodically is very important if you wish to close out the loan quicker and save money on interest that you pay over the entire loan tenor.
Make your own blueprint for cutting interest costs
You should first assess your entire financial situation and see where you stand. Ideally, the monthly home loan EMI should not exceed 30-40% of your net monthly income. Take into account your other liabilities and costs and your basic savings and investments, i.e. those that are geared towards other life goals including retirement, education of children and so on. Thereafter, find out the surplus amount you have. Work out the yearly surplus or 6-monthly surplus amount that you can afford to save up after meeting all the overheads including basic savings and investments.
Remember that paying a big amount is not always necessary. You can keep making small payments regularly and these play a big role in lowering the tenor of the home loan. Many people who are in their late 20s or early 20s often manage to pay off their home loans in just 9-10 years by making prepayments and hence they have more income in hand for a larger portion of their lives. As a result, once you see how much you can easily allocate for prepayment from your surplus monthly funds, have a strategy in place. You can make prepayments every 3 months or 6 months and this will keep reducing the loan tenor.
Some other strategies worth following
Make sure that you keep lowering the loan tenor instead of the EMI since this will help you close out the loan even faster. You can start with increasing prepayments gradually with increase in your salary/income and from your monthly surplus. You can start making prepayments every 3/6 months in this regard. This will keep cutting down interest costs and the tenor. You can also save up a fixed amount and prepay this each year while keeping the EMI unchanged.
You should also use your annual bonus and other incentives strategically. Any such expected lump sum amount can be used for making a big prepayment on an annual basis. You can also tap into some of your savings to periodically prepay your home loan since you will end up saving a lot on interest. Many people have unnecessary money back or endowment based insurance policies which can be closed and the proceeds can be deployed towards prepaying the home loan. You can also start increasing your EMI gradually in order to cut interest costs and lower the home loan tenor. Simply keep increasing your EMI by 10-15% every year and you can close out the loan faster. In case of any rise in rates of interest, do not increase the loan tenor but increase your EMI amount in turn. If interest rates come down, choose a shorter loan tenor as opposed to lowering the EMI.
Always have other goals such as retirement funds, education of your children and investments at the forefront. Do not sacrifice them at the altar of home loan prepayments. No matter how dramatic it seems, it is true!
What about home loan tax benefits?
Agreed, home loans do give tax benefits and in this regard, you have to take a conscious call. Many home loan borrowers often retain their loans to keep benefiting from these tax deductions, i.e. up to Rs. 2 lakh on interest repayment annually and up to Rs. 1.5 lakh on principal repayments annually. However, the best way forward is to analyse the overall costs and benefits.
See how much savings these tax benefits give you and compare them with the overall interest cost of the loan annually. This will give you the clear picture of what to do. In this context, many people find it better to first pay off their loans and then save and invest comfortably. Some people do prepay their home loans although they retain the figure needed for getting tax deductions.
A section of experts feel that paying up interest for tax savings is not a sound financial approach since the amount shelled out in the form of interest could be better invested in other channels for getting superior returns. Debt should always be closed out as early as possible according to most financial experts. The savings on taxes will always be less in comparison to costs of interest according to them. However, do keep in mind that your liquidity levels should never be compromised for making prepayments. You should not fall into a situation where prepayments hinder overall liquidity. Comfortably prepay your home loan and have a strategy for doing it. You will save considerably on interest as a result which translates into higher savings. Isn’t that music to all our ears?