When to Prepay Your Loan?
A Home Loan is a substantial financial commitment which often requires you to pay an almost hefty amount of sum every month, in the form of equated monthly instalments or EMI as it is popularly known.
What makes this commitment even more significant is the fact that the tenure of this credit type is often exceptionally long ranging anywhere between 10 to 30 years, implying that you ought to pay between a whopping 120 to 360 instalments towards the loan.
A Home Loan EMI comprises two basic elements – principal amount and interest. While the principal amount remains unchanged no matter the tenure, the interest increases with an increase in tenure. In a bid to save yourself from paying a greater amount of interest than you are required to, you can reduce the tenure of the loan by adopting one or more of the following measures:
- Opt for an increase in the amount of EMI, to match the rise in your income. This will help you reduce the overall tenure safely and steadily.
- Pay an extra EMI each year. Since most banks allow this practice, without any surcharges, you should try to pay 13 EMIs every year, instead of 12.
- Prepay the loan. This refers to paying off the outstanding loan amount in part or full, in an attempt to reduce the overall tenure.
While the first two alternatives are rather straightforward and don’t need any deliberation, you need to consider the prepayment of the loan in a different light. While most financial advisors advocate the prepayment of the loan, but even they suggest that it should only be done when you are still in the early years of your repayment timeline.
One of the principal reasons behind this is the fact that the prepayment often attracts a penalty which can be anywhere between 1% to 2.5% and in some cases even 5% of the outstanding loan amount, depending upon the terms you agree when you get a Home Loan.
Considering most Home Loans are offered for at least 15 Lakhs or more, the penalty, even if seemingly minuscule, can prove to be rather hefty, thereby nullifying the benefits of prepayment.
So, should you really opt for prepayment? Let us discuss when you should and should not contemplate paying off your Home Loan earlier than the scheduled completion tenure.
When Should You Prepay Your Loan?
1. If your bank levies very little or no prepayment charges.
In this case, it will prove to be extremely beneficial to make prepayments, even if in comparatively small amounts ranging from 1 to 5 Lakhs at a time. Every such payment will help bring down the tenure by several months, which will help you manage your finances more efficiently.
2. If you wish to enjoy added peace of mind.
For some people, it can be incredibly taxing to have debt under their name. Not only does a long tenure make such people feel genuinely uneasy, but also causes distress in other aspects of life, thereby hampering its quality. If you happen to be one such person, it is best that you pay off your debt as soon as you have access to any additional funds.
3. If you have no significant obligation in the near future.
When you have access to additional funds, it is only obvious to be tempted to clear off any debts. However, you should only take a call as crucial as prepayment, if you do not have any substantial financial obligations such as paying for your child’s education, sponsoring their wedding, or renovating your home, else you will end up taking another loan, going deeper in the debt chain.
When Should You Not Prepay Your Loan?
1. If the prepayment penalty at your bank is exceedingly high.
In case your loan agreement requires you to pay anywhere between 2.5% to 5% of the outstanding and prepayment penalty, you should seriously weigh the overall interest that you will save with the prepayment charges. If the interest tends to be higher, which is the case in most instances, you are better off paying the loan in the original format.
2. If you have other alternatives which require cash flow.
In case you have already repaid 50% or more of your designated EMIs and have extra cash at your disposal, it would be a better call to invest the money in opportunities that offer better returns such as mutual funds, bonds or shares. The math here is simple. You usually incur 10-11% interest on your loan. If the investment pays more than 11-12%, you can simply continue repaying your loan with EMIs and invest the funds elsewhere.
3. If you can avail Home Loan Balance Transfer at a lower rate.
A great way to enjoy a cheaper Home Loan is merely transferring your credit to another bank or lender, in place of a lower interest rate. This facility is known as Home Loan Balance Transfer or HLBT. If your overall savings using this facility is more significant than that you will make by prepaying the loan, you should opt for HLBT.
4. If you are in the later phase of your tenure.
In a bid to maximise their returns on loans, most banks ensure that the interest component of the credit is charged in the earlier stage of the tenure. Hence, towards the end, you are mostly paying the principal amount of the loan. In such a case, making a prepayment wouldn’t prove to be of a much benefit to you, especially if you are required to pay it along with a hefty penalty. Hence, you are better off investing your money in well-paying investment options or directing it towards other financial obligations.
We hope that you are now better-informed concerning the nuances pertaining to the prepayment of your Home Loan. We encourage you to consider all the aspects mentioned above before making a final call so that you are always on the advantageous end of the spectrum.
Also Read: The Do’s and Don’ts of Home Loan Prepayment
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