I have taken a home loan a year back. Now I would like to make a plan to streamline my future expenses. When is the ideal time to pre-close or make part-prepayments towards the loan?
Deciding on the closing depends on your finances, and it varies from person to person. But getting rid of debts fast is always good.
Majority of the EMI paid is allocated towards interest, especially during the initial 5-8 years of your loan. So, the best time to part-prepay your home loan is during this time. When you prepay, the full amount goes towards reducing your principal amount. This in turn reduces the total loan period and total interest outflow.
Another factor to be taken into account is the interest rate scenario in the economy. If there is an expectation that interest rates may harden going forward, it is a good idea to make some payments as an increase in rates in the economy will result in an increase in interest rate on your floating rate home loan as well. In this scenario, you may end up paying a higher EMI, or there will be an increase in the loan tenure. Remember, it is always better to reduce the tenure and pay off the entire loan before your retirement.
If you happen to receive lumpsum cash, you can compare the returns that can be received if it is invested and the interest on your home loan and make a good decision. You must also consider the tax aspect of a home loan, or in other words compare the interest rate on your home loan after considering the tax benefits when you make decision of prepay or invest.
Even though it is good to prepay your Home Loan (it will, of course, reduce your EMIs and help your Credit Score). But this may always not be the right thing to do. We’ll give you scenarios where prepaying is beneficial.
You Have No Other Loans
You have a 20 year Home Loan for Rs. 50 lakh. 5 years have already gone by. You receive a Rs. 2 lakh bonus. Let’s say the interest rate is 10%. Assuming you have no other loans and are enjoying tax benefits on the loan, it makes sense to prepay your Home Loan. This is because you will save Rs. 6,31, 979 of interest.
Not only that, your Home Loan tenure will go down by 1 year and 5 months. Since the tenure will still be over 10 years, the interest portion will continue to dominate your EMIs and you can keep claiming your tax benefits.
You Just Started Repaying Your Home Loan
In the initial years of your Home Loan, the interest component makes up close to 90% of your EMI. So, when you prepay you save big on interest payments. However, as you near Loan maturity, your principal repayment will be much bigger than the interest component and prepaying may not be beneficial, especially if you are availing tax benefits.
Here’s an example. Assume you have Rs. 50 lakh Home Loan with 10.5% interest rate and 20 year tenure. Your interest payment will be Rs. 3 lakh a year while principal repayment will be close to Rs. 50,000. If you prepay Rs. 2 lakh of your principal when you are just 2 years into your Loan, you will save Rs. 8.8 lakh of interest. If you do it after repaying your Loan for 15 years, you will save only Rs. 1.2 lakh.
So, prepaying a Home Loan that is near maturity is less beneficial when compared to prepaying a Home Loan that is newly taken.
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