If you ever met Narendra Jain you wouldn’t miss the twinkle in his eyes, ever since he moved in his new home. “Thanks to HDFC Home Loan or I would never be able to realise my dream of moving in this apartment”, you would often hear him say. But of late that spark was missing; the gloss on his cheeks had evaporated. Now all he spoke about was the burdensome EMI. One day, when he could take no more, he decided to prepay his loan using all his savings. Wait Narendra, wait! Don’t act on an impulse. Read this article before you take the next step forward.
With a home, comes a package of joy and a sense of pride. But most people fall short on preparing themselves for the long term responsibility that a home loan brings. It’s a natural tendency for people to prepay the loan as soon as possible. They start diverting all surplus funds towards prepayment without giving it much thought, except it is not the best idea. Here are a few tips you must keep in mind before you rush to bank with your next paycheck.
Having the whole of your income at your disposal, without any EMI deductions, is an enticing option. A lot of people would argue that one must use the savings today to prepay a loan and then re-save that amount over a period of time.
Jain had calculated that if he were to prepay the outstanding loan amount of 37 lakhs then his EMI of 45K would be freed every month. He planned to save this 45K in a separate pool and in a few months exceeding 6 years, he would be sitting over 37 lakhs again, given a standard rate of compounding and taxation; that is if he were to save 45K every month, without fail and without withdrawals.
While the idea sounds good on paper, but it leaves you cash dry. What he failed to consider were emergencies, what if there was a break in a steady stream of income, the rate at which his existing pool of savings would grow over 6 years etc. Upon meeting an emergency, Jain may have to seek a personal loan, which would evolve into higher interest payments.
Banks these days offer a very interesting and useful product – Top-Up home loans. When you have repaid your home loan for some time and a fresh need for funds arises then you needn’t rush to apply for a personal loan or take a loan on your credit card. Those are far costlier options. Rather you could approach your home lender and seek a top-up loan. This loan is an extension of your existing home loan, against the value of the same property. Being a secured loan it is far cheaper than a personal loan and if the funds are used for home related expenses then you can enjoy tax rebate on interest paid. Think about it Narendra!
Several banks and HFCs attract existing home buyers by offering a lower rate on existing home loans. Often they would takeover a competitor’s home debt and add it to their own pool of assets. The homebuyer gets to save more due to a lower rate and it often eases the eminent pain of a high EMI. Have you checked for “Balance transfers”, Mr. Jain? Use a home loan EMI calculator to calculate the new EMI. Take into account the processing fee, prepayment penalties etc. before you transfer to another bank.
If it wouldn’t hurt Narendra’s monthly expenses then we would recommend him to rather have his EMI increased. Perhaps, from 45K to 55K. This way he will be paying off his home debt sooner than his regular tenure and will not have to move his savings for it. You might find it odd because Narendra is already feeling the pinch of 45K yet we are asking him to spend 55K. It is better than losing 37 lakhs in a single stroke, let alone the interest it would earn over the years.
Received a bonus? First allocate a portion to creating an emergency pool. Incase there is no other expense in sight then use these surplus funds to pay off your outstanding debts.
Several investments may yield a higher rate of return than that you pay on your home loan. For one, you do enjoy a tax benefit on interest paid on home loan. So the effective rate of interest is much lower. While at the same time certain investments may help you with returns far greater than the amount of interest you save by prepaying a loan. Call up your CA today Narendra.
Whenever we talk about a home loan, we cannot ignore the fact that upon foreclosing it we shall cease to enjoy the associated tax benefits. Actually, a home loan is a cheaper form of debt and therefore it is better to keep it than use your savings to prepay and later take a loan at a higher rate.
If you have crossed the 50% mark of your tenure then it does not make much sense to prepay it today as you would have paid most of the interest. Never quit a loan without doing the math on it. Take a look at your amortization schedule, Narendra. You may learn that there could be a better use of your savings than prepaying the loan.
We don’t say that one must never prepay a home loan. Rather the point we are driving home is that one must examine the decision through all aspects thoroughly and only prepay if it yields benefits.
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