According to a survey conducted by Home Credit India, nearly 2 out of 3 Indians are ready to take a home loan. The reason is not just the desire for luxury, but also that sometimes home loans work out quite viable financially. For those that have home loans, it is inevitable for prepayment to cross one’s mind.
“I have a lump sum saved up, should I use it to pay off my home loan in advance?”
This is a question that we often get asked. One might have earned a handsome bonus or won the lottery, or would simply have saved up regularly. Is it wise to prepay your home loan with this surplus? Or should you rather invest the surplus and continue paying your usual EMIs? The answer is slightly more complex than a simple “yes” or “no”. And today, that’s exactly what I want to discuss with you.
Paying off your home loan before the due date, whether in full or in part, depends on a few factors.
1. Tax benefits
The EMI we pay for a home loan has two components, the principal and the interest. Indian income tax laws provide separate benefits for both these components.
Section 80C of the Income Tax Act stipulates a deduction of up to ₹1.5 lacs per year for the principal component.
Section 24 allows a deduction of interest on home loan of up to ₹2 lacs per year.
Put together, it is possible to get a tax benefit of up to ₹3.5 lacs with an existing home loan. This deduction can reduce the taxable income considerably, thereby lowering your tax payable, depending, of course, on the tax slab you fall under.
2. Rate of interest of home loan
When we compare interest rates on various types of loans, the rate of interest on a home loan is the lowest. Currently, the rate is around 7%. By contrast, the rate of interest on credit cards can be as high as 45%. Personal loans can cost anywhere between 10-15%. So, one question to ask while prepaying your home loan is, “Do I have any other sizable, impending expenses?”. For instance, maybe you’d like to buy a car. In such cases, it is best to continue the home loan and use the surplus funds elsewhere.
3. Rate of interest on investment
Another important factor to consider is the rate of interest that we earn on our investments. If we invest in fixed deposits, the effective interest rate could be as low as 4-5%, while investing in mutual funds or shares could give us a return ranging between 8-12%, or higher. When we invest in avenues that generate a return higher than the interest rate on the home loan, it is sensible to continue with the home loan and not prepay it.
On prepaying a partial loan, we get two options. We could either reduce our EMI or we could decrease the tenure of the loan. There may be prepayment charges depending on the financial institution that you’ve taken the loan from.
While all the above aspects are purely financial in nature, it is common knowledge that loans also have an emotional impact. For most of us, being debt-free gives us an unparalleled sense of financial independence. For this reason alone, prepayment of a home loan would be wise.
Do you have a home loan? Has the question of prepayment ever crossed your mind? Feel free to reach out in case you would like to talk about this further, and about loans in general.
