You have surplus funds in your hands. Should you prepay your Home Loan? Many people face this dilemma. It is tempting to prepay the Home Loan and become free of debt. It is a good idea, but there are better ways of using this money. Consider the following factors before deciding your further course of action.
1. Funding for Emergencies
Remember that your Home Loan account is not revolving credit. Once you make the prepayment, you cannot withdraw the same under any circumstances. Hence, it makes sense to keep aside funds for an emergency. Emergencies can come unannounced. You can have a wedding in the house. A medical emergency can arise at any time. If you prepay your Home Loan, you can be cash-strapped to meet these emergencies. As a result, you end up borrowing money at a higher rate of interest. Therefore, set aside a specific sum of money for your emergency situations. In case you still have a surplus, you can go ahead and prepay your Home Loan.
2. Consider Putting the Fund to Better Use
The Home Loan is the least expensive of all your other investments. The average rate of interest on your Home Loan is around 9%. If you prepay your Home Loan, you will save a lot of interest cost. There are better investment opportunities where the returns on investment are higher than 9%. Compare long-term investments with your Home Loan because your loan is a long duration loan. One of the best investments is equity investment. Recent trends show that the BSE Sensex has given annualized returns in the range of 15%. Your Home Loan interest component of 9% pales in comparison. However, you should also consider the risk factor in such investments. A long-term equity investment is at lower risk as compared to other short-term investments. Hence, investing your funds in such products is a wise decision.
3. Stage of the Home Loan
Why do you prepay your Home Loan? The primary objective is to save interest. In a Home Loan, the initial EMIs have the highest interest component. As you go deep into your Home Loan, the interest component reduces. Hence, prepayment at an early stage of your loan is beneficial. A prepayment in the middle or final stages of the Home Loan will not give you the full benefit of savings on interest. It is better to look for other investment opportunities under such circumstances.
Also Read: The Evolution of Home Loans in India
4. Compare the Rate of Interest on Other Loans
The Home Loan is the most comfortable loan to service because of the lower interest rate. In case you have Personal Loans and Credit Cards attracting a higher rate of interest, it is better to close them first before thinking or prepaying your Home Loan. It is advisable to liquidate your higher interest-bearing loansas against your Home Loans.
5. Tax Benefits on Home Loan
The Home Loan is attractive for two reasons. One is the low rate of interest. The second reason is the income tax benefits you get on the repayment of your Home Loan EMIs. You can claim up to Rs. 3,50,000 on repayment of interest and principal amount under various sections of the Income Tax Act 1961. The Government of India is focusing on providing homes for all Indians. Under such circumstances, the concessions in income tax will continue for a long time. Prepaying your Home Loan will result in forgoing these income tax benefits.
6. Prepayment Charges
Until recently, banks were charging prepayment penalty in the range of 1% to 2% of the outstanding amount, especially in ‘Home Loan Balance Transfer’ cases. Reserve Bank of India has directed all banks and other home loan financing institutions not to charge any Home Loan Prepayment Charges or foreclosure penalty under any circumstances. However, it is advisable to check out with your bank before you decide to prepay your Home Loan.
Indians have a high aversion towards debt. We agree that a Home Loan is a long-term debt proposition and a large one at that. However, you can manage your home loan debt with some effective planning. Regular repayment of your EMIs is the best way to handle your Home Loan debt. Home Loan insurance is also a good option. It safeguards the interests of the family members in case of untoward events.
To sum up, one should explore other fruitful options before deciding to prepay the Home Loan. Do not compromise on your liquidity position in your haste to close your home loan prematurely.
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