NEW DELHI: Home loans are usually very long-term liabilities with tenure running from 20-30 years. It is always a psychological burden on an individual to have a liability over such a long period.
Therefore, it is always advised to pay off the home loan before the full tenure of the loan. Of course, it not only sets you free from liability, it also helps you save on interest cost.
Typically, in a 20-year home loan, one ends up paying up to 100-130% of the loan amount as interest depending on the average interest rate over the tenure of the loan.
For example, for a 50-lakh loan over 20 years at an average interest of 10%, one would pay R65.80 lakh in interest. If the average interest rate is 9% over the tenure of the loan, you pay an interest of almost R58 lakh on a loan of R50 lakh.
Paying off early can reduce the interest cost by a substantial amount, depending on how and when you are prepaying the loan.
Continuing with the earlier example, where one takes a R 50-lakh loan over the 20-year tenure at 10% interest. After 10 years of paying the EMI, the outstanding loan would still be around R36.69 lakh.
If one pre-pays R10 lakh at the start of the 11th year, his loan would be fully paid off in the next 74 months (instead of 120th). And the overall interest cost comes down by 18.5% to R53.65 lakh (from R65.80 lakh).
Clearly, there is a strong case for pre-paying your home loan. Ways of pre-paying home loans The good thing about home loans is that prepayment or early closure of loans do not attract any additional cost.
The Reserve Bank of India (RBI) has prohibited banks from charging any prepayment penalty or foreclosure charges on floating rate loans. Most home loans come with floating rates, which means banks can change interest rates as and when required.Therefore, it makes all the more sense to prepay your home loan to not just reduce the interest cost but also close it ahead of the tenure.
Here are the different ways in which one can prepay the home loan. Increasing the EMI: For the first couple of years after taking the home loan, you may feel the EMI heavy on your monthly budget. But subsequently, with increase in salary or income, one can afford to increase the EMI and pay off the loan earlier than the full tenure.
A good 20-25% increase in monthly EMI can substantially reduce your loan tenure as well as the interest cost. The EMI increase can be done through an online application without having to go to the bank branch.
Paying lump sum amount: Another way is to make payment in lump sum amount after an interval. It can be a one big payment after say after 10 years, or smaller amounts every 2-3 years. Even a R2 lakh payment of principal can bring down the EMI tenure by a few months, meaning quicker closure of the loan and as a result lower interest cost.
Balance transfer: One can transfer the outstanding loan to another bank which is charging a lower interest rate. Balance transfer usually comes with a cost, therefore, it is advised that one should opt for the balance transfer only if the difference in the rates is high.
While shifting to lower rates, ensure you do not reduce your EMI amount. That way you benefit from both a lower tenure and a lower interest cost. Usually, your existing bank also offers you a lower rate after charging a nominal fee. Do check this option first before transferring your balance amount to another bank, unless you have more reasons to change the bank.
“Prepayment of home loans can help you save interest. Even if you make the part payment, you can either ask the lender to reduce your home loan EMI or it can simply help you in reduction of tenure,” says Pankaj Mathpal, founder and managing director of Optima Money Managers.
Right time to pre-pay
However, experts advise people to make the prepayments in the early part of the tenure rather than at the fag end of the tenure.According to Pankaj Mathpal, it may not be a wise decision to prepay the loan especially when you have already completed a large part of the tenure because in the end a major part of your EMI goes towards principal and only a small portion goes towards interest.“You may like to invest the capital instead of repaying the loan as the interest burden is very low. Also, you should consider the tax benefits on loan before you plan to foreclose it,” he says.