Aakash, 35, had taken a home loan five years ago and wants to get rid of it as soon as possible so that he can invest his savings in the things he really wants like travel. He recently switched jobs and since it was Diwali, he received a bonus over and above the hike in his salary. This left him with a lot of extra spending power in his hands. He immediately began considering prepayment of home loan. However, the cost of prepayment in terms of penalty and tax-saving opportunities, investment opportunities, etc. confused him. If you are in a similar spot, here are three things you can keep in mind before you make a decision.
Sooner rather than later
The primary objective of repaying a loan earlier than it is due is to reduce the amount of interest for the remaining instalments. Benefits of home loan prepayment also include reducing the remaining duration of the loan. A majority of home loans are designed in such a way that the first few EMIs are payments of the interest component. When you prepay a large amount, you are repaying the principal amount and thus reducing the interest on the remaining principal.
While making a prepayment of home loan, you are given two options- either reduce the EMI or reduce the duration of the loan. As alluring as reducing the duration of the loan sounds, it can also add financial pressure and stress to your planning which might just be unnecessary. You can instead save up every month and when you reach a significant amount, repay as a lump sum amount. This way, your savings are available for other emergencies as well.
Some loan providers charge what’s called a prepayment penalty when you decide to prepay your loan. When you prepay a loan, you basically pay the bank or loan provider less money than you would have otherwise, because of reduction of interest. It is obvious that they wouldn’t want that. Hence they charge a prepayment penalty when you decide to pay back a larger amount than you are supposed to. A lot of banks do not charge this penalty these days, but some still do. If you want other benefits like fast online processing and minimal documentation along with no prepayment penalty, you should check out the Bajaj Finserv Home Loan, available on Finserv MARKETS. You can get your hands on loans of upto Rs 3.5 crores, along with provisions for Top-Ups of upto 50% of the sanctioned amount. You can also reduce your existing home loan EMI by transferring your loan to Bajaj Finserv Home Loan using the Home Loan Balance Transfer facility.
If your bank does not charge a penalty, you have two options when you have a surplus of money in a particular month. Either save/invest it or prepay your loan. Saving it in a fixed deposit might not give you enough ROI since interest rates are always below 10%, so that option is out. As far as investment is concerned, it depends on what you are investing in. It also depends on the volatility of your investment. If you invest in an equity fund, you have a risk. What you have to do is compare the opportunity cost in terms of money spent and gained/saved in both cases- prepayment of loan vs investment. If you aren’t earning more from your investment than you would save by prepaying your loan, benefits of home loan prepayment are scarce.
Home loans provide tax benefits. The principal amount of home loan EMI is eligible for deduction under Section 80C of the Income Tax Act, with an upper limit of 1.5 lakhs. The interest on home loan is also tax-deductible under Section 24(b) of the Income Tax Act (maximum of 2 lakhs p.a for a self-occupied property and no upper limit for a Let Out Property). Once your loan is paid off, you lose the tax benefit and will have to look for another tax-saving investment. Make sure that you have this planned much in advance. There are various other options under Section 80C that you can avail of.
There are a couple more things to keep in mind when you decide for prepayment of home loan, like the tenure of payment left, documentation, ensuring that you have enough savings for emergencies, etc. If you choose to repay a large sum, the interest saved would usually outweigh the prepayment penalty, so the benefits of home loan prepayment are plenty. If you don’t want the hassle of prepayment penalty at all, you can go for a product like the Bajaj Finserv Home Loan, available on Finserv MARKETS, which also offers a flexible repayment tenure of upto 300 months amongst other benefits.
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