10 things to keep in mind before prepaying a home loan

To buy residential property, home loans are one of the best options available to a home buyer. Home loans are secured loans offered by banks, NBFCs and other financial institutions. Home loans can be used for move-in ready homes, property under construction, repairs and renovations, among others. However, interest rates on home loans vary from lender to lender. They usually have a term of 10 years to 30 years. Homebuyers can repay their dues in equivalent monthly installments (EMI). Notably, the lenders also offer the prepayment option, which means a borrower pays an amount of their fee greater than the EMI amount before the scheduled time.

By repaying home loans early, borrowers can save a substantial amount on interest expense and lighten their financial burden.

Here is a list of key points to remember before prepaying your home loan.

According to Nitin Jain, Chief Client Officer and Head of Operations at Godrej Capital, the following factors should be considered:

A home loan is a long-term financial commitment and often the interest component exceeds the principal amount due to the long term of a typical home loan of 20-30 years.

2. With prepayment, a home loan borrower can choose to reduce the EMI amount or the term of the loan. By reducing the term of the loan, the borrower keeps the same amount of EMI, but the principal part of the EMI increases, thus repaying the overall loan even faster. By reducing EMI, a customer can enjoy more disposable income. Depending on the stage of the client’s life, either option can be chosen.

3. Since a home loan has tax savings, prepayment may affect tax savings on outstanding principal and interest expense. Therefore, before prepaying, a borrower is advised to consult an independent tax professional to understand the tax benefits they may be forced to forfeit to prepay a home loan.

4. Also, it is better to opt for the prepayment option of the home loan during the initial term of the loan when the interest component is high. Opting for prepayment at a later stage may not help maximize the benefit of being debt free sooner. Thus, timing plays a crucial role in prepayment.

5. Finally, although paying off the home early can help reduce interest charges, one can also opt for an alternative, i.e. transferring the balance of the home loan, provided that it is there are lenders in the marker that offer lower interest rates with no fees or hidden costs. This can significantly reduce interest payments without affecting savings and investments. For example, a borrower five years ago was granted a loan of INR 40 lakh at an interest rate of 7.70% for a term of 20 years. The current outstanding is said to be INR 33.5 lakhs. Now, if this loan amount is transferred to another lender at an interest rate of 7% for the remaining tenure, the borrower can successfully save about INR 6.9 lakhs in interest charges without deploying his savings.

Meanwhile, Jairam Sridharan MD of Piramal Capital & Housing Finance highlights the following pointers:

6. When a borrower makes partial payments for home loans, either the term of the loan is shortened or the EMI decreases. Depending on the requirement, the borrower should carefully evaluate and choose between the two. A reduction in tenure will help save on total interest payable, and the reduction in EMI will reduce monthly outflows.

7. Emergency funds set aside for unforeseen events should be kept intact and the borrower can use other alternatives to prepay the home loan. It is impractical to deplete emergency funds and then borrow costly additional funds when the unexpected need arises.

8. Prepaying the home loan early during the first part of the loan term is always a good option. This can help reduce the EMI or pay a much lower amount of interest on the reduced outstanding principal after prepayment. If a borrower receives a lump sum in the latter part of the tenure, it may make sense to invest it elsewhere and repay the home loan under the normal tenure. The borrower can also seek help from the lender to choose the best EMI option.

9. Individuals generally do not have to pay prepayment fees or charges for their variable rate mortgage. However, it is always advisable to check for any hidden charges to avoid any surprises. Borrowers should seek help from the lender to know the terms and conditions and clarify any doubts before making the prepayments.

10. Investments set aside for other long-term goals such as retirement planning, children’s education, and other important costs should ideally not be liquidated for prepayment of home loans. This could have a negative impact on long-term financial health and borrowers may be forced to resort to expensive loans to achieve their financial goals.

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About Evelyn C. Heim

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