Key Factors to Consider Before Prepaying Home Loan
Mamta Sinha
Paying off a home loan ahead of tenure, commonly known as prepayment, can be an enticing prospect for many borrowers. It offers the freedom from debt and substantial interest savings. However, before embarking on this financial journey, it’s crucial to weigh various factors to ensure it aligns with your long-term financial goals.
Prepaying a home loan involves a comprehensive assessment of your financial circumstances, loan terms, and future goals. While reducing debt is advantageous, it’s crucial to strike a balance between prepayment and other financial requirements. Let’s delve into the critical considerations before making the decision to prepay your home loan, particularly in times of higher interest rates or when the rates are moving northwards.
Interest Rates
Analyse the current home loan interest rate against potential investment returns. If your loan interest is significantly higher than potential returns, prepayment might be beneficial. Understand whether your home loan has a fixed or floating interest rate. Prepayment benefits may differ based on the type of interest. Consider paying off higher-interest debts before prepaying your home loan. Prioritise clearing debts with higher interest rates.
Loan Tenure
The tenure of your loan is decided based on your repayment capacity and preference at the time of borrowing. This is one of key factors that influence your home loan repayment process. Evaluate how far you are into your loan tenure. Prepaying in the initial years can save substantial interest compared to prepaying in the latter part of the tenure.
Investment Opportunities
It is not always prudent to prepay your home loan and hampering the opportunity to earn higher returns on your investment. Some people break their key investments just to pay off their loans which they can easily manage. That is why, it is recommended to assess potential investment opportunities. If alternative investments offer higher returns than your home loan interest rate, it might be more financially prudent to invest or remain invested rather than prepay.
Terms and Conditions
Check if your lender imposes any prepayment penalties or charges. Sometimes, these costs might outweigh the benefits of prepayment.
Partial vs Full Prepayment
Understand whether your lender allows partial prepayments or only accepts full prepayment. This can affect your strategy in managing surplus funds. A full pre-payment or foreclosure means complete pre-payment of the outstanding loan amount. On the other hand, partial pre-payment means paying a portion of the outstanding loan amount once or multiple times during the loan tenure. According to Adhil Shetty, CEO, Bankbazaar.com, It makes sense to partially pre-pay your home loan when the interest rates have risen regularly. At a time like this, borrowers must have a payment plan. Your original loan plan may be for 20 years, and your intention may be to pay it off in 10 years, and the interest rate hikes may have taken the tenor to 25 years. The key is to be debt-free as intended, and not allow inflation to elongate the time you remain in debt. If you wish to still be debt-free in 10 years, you’ll need to pre-pay. Calculate what you need to pre-pay to gradually reduce the tenor from 25 to 10 years. A future fall in rates will also help you. A simple method is to split your loan balance by the number of years in which you want to pay it off.
For example, your loan balance is Rs. 50 lakh and you want to pay it off in 10 years. Therefore, ensure that Rs. 5 lakh is paid towards the balance each year through a combination of EMIs and pre-payments. This way, the amount you need to pre-pay gets smaller each year as your EMI principal payments get bigger and interest payments get smaller.
Tax Benefits
A borrower enjoys tax benefits while repaying his home loan. When you decide to repay your home loan before the tenure you must consider the impact of prepayment on tax benefits. Prepayment might reduce the tax benefits available on the interest component of the loan. In the end, the decision to prepay a home loan should align with your overall financial strategy, ensuring it helps you save money and helps you invest and grow your funds. You must evaluate all these factors before closing your home loan.