Several people achieve their urban dream of buying their own home by availing a home loan. Also, being averse to debts, many prefer to pre-pay the loan, but, when it comes to pre-paying a home loan, there are some important factors which should be considered. Shilpa Shah guides us through it.
Pre-payment is a facility, which allows the borrower to repay the loan in part or full, before completing its tenure or due date. Sometimes, people choose to pre-pay loans, since they have been conditioned to believe that being debt-ridden is not good, and hence attempt to be free from any financial debts. Also, it seems practical to foreclose the home loans to save on the increasing interest rates. However, a housing loan being a big amount, is unlike other loan such as a personal or an automobile one, and involves multiple factors; therefore, it is important to evaluate them while making the pre-payment.
PLAN FOR YOUR FINANCIAL NEEDS
While considering the pre-payment option, you must take into account all your financial needs or expenses such as children’s education, travel, marriage, medical insurance, etc. You must
ensure that you have enough funds to meet all your financial goals in a sustained manner.
It is also a good strategy to pre-pay in parts while foreclosing, instead of paying the full amount, so that one doesn’t end up being fund-strapped and has sufficient funds to take care of one's unexpected financial needs. Puskhar. J, a Senior Manager with a consultancy firm, has opted to pre-pay his housing loan in parts, with his yearly bonus and other incentives. Since he also has a growing child, he has created a corpus to fund future education expenses, as well as pay off his existing car loan. He suggests, “Everyone should do a detailed financial planning of their life goals, so one can plan one’s outflow accordingly. Also, there is no need to wait for a huge sum to start paying back; even small payments go a long way in helping reduce the loan burden.”
DON’T DIP INTO YOUR EMERGENCY FUNDS
These are funds that are ear-marked for any urgent requirement, such as any medical emergency, or loss of income due to unemployment or disability or any other unforeseen event. In fact, while planning to
pre-pay your home loan, make sure you have enough liquid funds, so that in case of any emergency, you are in a position to manage your expenses for at least a few months. Hemant Rashinkar, an IT consultant, too, vouches for this safety net. Since he looks after his older parents, he has planned well for any medical exigency, while also pre-paying his loan. He cautions, “Come what may, do not touch your emergency funds to pay off your home loan, or you will be forced to borrow money at higher rates during an emergency and may also have to trade-off your other investments at much lower rates, thereby incurring a financial loss.”
INCOME FROM OTHER INVESTMENTS
While pre-paying your home loan, you must also evaluate and compare the cost of pre-payment with your income from other investments. Take the example of Vaibhav K. (Joint GM, with a leading bank), who prefers to continue with his home loan (availed at lower rates in early 2000), instead of pre-paying it completely. His logical approach being, “Always consider the opportunity cost (benefits an individual or an investor misses out on when choosing between alternatives); take expert guidance to understand the market and depending on your own risk appetite and goals, check for suitable avenues where the return on investment (post-tax), is higher than your home loan rate.
If there are such options, then it is beneficial to invest your surplus funds in them (subject to market conditions), instead of rushing to pre-pay your home loan.”
TENURE versus EMI (Equated Monthly Instalments)
Finance expert, Rahul Kolangde, throws some light on the debate between the reduction of EMI or tenure. He advises, “To save on interest expenditure, it is better to reduce your tenure than decreasing your EMI amount.” He also recommends, “Start pre-payment early with the help of systematic financial planning.” And this is exactly, what Pranav Joshi, Business Head with a reputed MNC, accomplished with his planned and disciplined approach. Since he was smart enough to have invested in a home in the initial years of his career, while his family expenses were still low, he could manage to start repaying early. According to him, “With higher income and other arrears, that come along with growth in career, it becomes feasible to pre-pay the loan by increasing or at least maintaining the EMI amount and keep chipping away the loan tenure.” However, he suggests, “In your younger years, try not to splurge your hard-earned money on frivolous expenses, instead focus on ways to reduce your loan burden.”
One of the critical factors, while considering pre-payment of home loan is the tax benefit. On full prepayment of home loan, one is no longer eligible for tax benefits and in case of part pre-payments, one does get lower tax benefits. This is reason, why many choose to continue with their home loans. However, in some cases, the interest payment may be much more than the actual tax savings. In such a scenario, it is advisable to pay off the loan. Chartered Accountant Harshada. H., informs, “Home loan repayments are eligible for tax benefits under the Income Tax (IT) Act. These are claimed as deductions under different sections, while filing IT returns. Maximum deduction allowed on repayment of the principal amount is #1.5 lakh (under Sec 80C) and #2 lakh on the interest paid (under Sec 24)”.