Home Loan Prepayment

Here is a brief overview of how this tool works exactly. As an example, consider the following numbers for illustration and elaboration purposes:

• Principal Home Loan Amount = ₹40 Lakhs

• Tenure = 20 years

• Rate of interest = 9% p.a.

Using a home loan EMI calculator, you get an EMI amount of ₹35,989. This instalment amount is your monthly outflow towards your home loan repayment.

Say you prepaid a sum of ₹2 Lakhs in one go, which will consequently reduce your EMI amount to ₹34,190, which means that you will save ₹1799 every month. Alternatively, you can choose not to get any changes made to your monthly EMI amount and get the repayment tenure of the home loan reduced instead. 

Once you are familiar with the aforementioned variables, key in the details in the online calculator to determine the final EMI amount you will have to pay post prepayment.

Banks or housing finance corporations charge prepayment fees so that they can partly make up for the interest revenue that they may lose as a result of prepayment.

In some cases, lenders even charge a home loan prepayment penalty.

A prepayment penalty is generally levied on home loans at fixed interest rates. This penalty is levied to cover the loss of interest on the home loan. 

While this penalty can vary between 0.5% and 3% of the total amount, note that it can vary depending on your loan agreement terms.

1. When Banks Cannot Charge a Penalty

Banks cannot charge a home loan prepayment penalty under the following circumstances:

• No prepayment charges should be levied on home loans taken with floating interest rates

• When the prepayment of a home loan is initiated using your own source of income, lenders are not allowed to charge any prepayment penalty

• If you decide to change the interest type from fixed to a floating rate, the lender will not levy any prepayment charges

2. When Banks Can Charge Prepayment Penalty

Banks can charge a prepayment penalty under the following circumstances:

• If you avail home loans at a fixed interest rate, you can be charged prepayment fees

• When you procure your home loan from ‘non-individuals,’ such as a co-borrower or a third party, such as a company or firm, you are liable for prepayment charges

It is important to know the RBI guidelines to ensure that you do not end up paying extra prepayment charges on your home loan. Hence, it is prudent to go through the terms and conditions of the loan agreement to know about the consequences of home loan prepayment when opting for a home loan.

Given that the interest component of EMIs is higher in the initial period than in the later years, you will not save much if you repay the home loan towards the end of the tenure. 

• Alternate Use of Money

You can use the surplus influx of cash to reduce your debt burden. Alternatively, you can use the surplus money to make investments, earning you better returns and helping you build your wealth. 

• Age

If you are close to retirement, foreclosing the loan to avoid defaults is an ideal option at a time when you do not have an income source. 

However, if you are young, have a stable income source, and have other expenses to take care of, you must think twice before prepaying. Ultimately, the decision of prepayment lies in your hands, and you must do what works best for you.

• Future Requirements

You must consider your future monetary requirements and plans before prepaying your home loan. Although it is ideal to get out of debt early, prepaying a home loan can deplete your savings as it involves a massive amount.

• Tax Benefits

Home Loan EMI payments entitle you to enjoy home loan tax benefits under various sections of the Income Tax Act, 1961, and help you save lakhs of rupees each year. However, to avail them, you must meet the conditions laid out under these sections. 

If you make a full prepayment, you can no longer claim tax benefits. This, too, is a critical aspect you must consider when thinking of home loan prepayment.

• Penalty

The foreclosure of home loan amounts may attract penalties. It may go as high as 6% of the total loan amount. So, you must only opt to close your home loan early after knowing all about the prepayment penalties.

• Loss of Savings

You will only be able to make a home loan prepayment if you have sufficient surplus money. When you plan to foreclose the loan using your savings amount, it can deplete your funds. So, considering other financial commitments of life is essential before submitting a huge chunk of money to your lender.

• Loss of Tax Benefits: 

When you claim for tax deductions at the end of the financial year, the loan repayment of your home allows you to get a tax deduction of up to ₹2 Lakhs. Hence, if you foreclose your home loan, you may lose out on tax deductions and get lower tax benefits.