Do you wish to prepay your home loan? Managing a home loan adroitly is very important and many a time, customers rush to prepay home loans at the first possible instance. Yet, there are things that one should always keep in mind. Consider examples of borrowers who have prepaid home loans in a disciplined manner with all the bonuses, interest income and other incentives that they received. In the process, these borrowers have saved considerably on the overall interest costs of home loans.
It may often seem that prepayment of home loans is a tough task. However, with some proper planning and a disciplined approach, it is very much possible. As per several reports and studies, 65-70% of home loans taken in India are usually paid off in a period of 7-9 years. It’s not always that one has to wait it out for receiving a windfall in order to make loan prepayments. Regular and smaller payments can contribute hugely towards lowering the overall tenor of the loan and the interest burden. People who are purchasing homes in their late 20s or even early 30s can clear home loans within 7-10 years depending on how they utilize annual bonuses and increments.
Useful Prepayment Strategies
Whenever one is prepaying a home loan, the preference should be geared towards lowering the home loan tenor instead of lowering the EMI since the former strategy will enable higher interest savings as per experts. Suppose there is a home loan of Rs. 50 lakh at an interest rate of 9% and a loan tenor of 20 years. This can be paid off in less than 10 years if you make periodic prepayments of Rs. 3 lakh at the end of each year while keeping your EMI unchanged. You can start making a small prepayment and scale it up over a period of time.
The first prepayment will be made in the 7th month post taking the loan and prepayment can increase by 10% with more monthly savings and bonuses that you can deploy every 6 months. You can also keep the EMI constant and prepay a fixed sum annually. However, the best way out is to start smaller and gradually scale up the amount for prepayment by at least 10% on a half-yearly basis. Savings may not be high in the initial 2-3 years since there are costs of decorating and furnishing the home according to experts. With an increase in salary over the near future, prepayments can be made accordingly.
Other ways of prepayment
Many people purchase money-back or endowment policies and pay the premiums in spite of these financial products offering lower returns. They can seek out these policies in their financial portfolios and in case the policies have attained the surrender values, they can be terminated and the latent proceeds can be used for prepaying the home loan. In case the returns are low and premiums are on the higher side, you can always execute a comparison of the benefits and costs at hand in order to see whether terminating the policy will be a wise decision.
The amount that you pay for premiums can be useful when it comes to prepaying the home loan and also improving overall flows of cash. Old investments can also be ferreted out and liquidated for prepaying the home loan. You can also steadily increase the EMI in case you do not have major savings or other funds. This will help you repay the loan in a faster amount of time. You can increase the EMI by 10-15% on a yearly basis in order to repay the loan swiftly. In case of increasing rates, increase your EMI instead of the loan tenor. In case of lower rates, choose a shorter home loan tenor without lowering your EMI.
These strategies will help you prepay the loan in a shorter period of time. You should also keep your other financial objectives clearly in mind without ignoring them at any cost. Prepayment always equates to greater mental relief since a home loan is certainly a major debt burden for any household. However, several customers only focus on prepaying the home loan but they forget other goals like saving up and investing for their retirement, education of their children and so on. Always analyze your investment and prepayment strategy in order to make sure that it does not sap your financial resources and eat into your other financial goals.
Taxation and other aspects
Many home loan customers often put prepayment on hold in order to keep benefiting from tax deductions on home loans. This is up to Rs. 2 lakh on interest repaid annually under Section 24 and up to Rs. 1.5 lakh on principal repayment under Section 80C. However, many people have executed analyses of the costs involved in paying interest and the benefits offered by way of tax deductions. In many cases, the interest outgo was higher than the tax deductions on offer. As a result, they found it a better strategy to clear out the home loan first before deploying their savings into better channels for earning superior returns.
Some experts also feel that prepayments can be suitably structured in order to help retain the amount that is needed for getting tax deductions that are needed. There should be a middle ground where you continue making prepayments on your home loan while also getting tax benefits on the remaining amount as per experts. Yet, most experts feel that retaining tax benefits by paying a high amount of interest will not be a wise strategy in the long run. Suppose you invest the amount paid via interest on the home loan into other avenues, you may actually get better returns. The taxes saved will be comparatively lower if you take interest costs into account.
As a result, do not hold off prepayment in order to retain your tax benefits. Take into account your current investments and make sure that you should not sacrifice them and also overall liquidity for making prepayments at the same time as well. This desperation on your part will only lead to taking loans that are costlier later on, like personal loans, for meeting emergencies and pressing financial requirements.