Prepayment of home loans can help cut costs and offer quick debt relief, but the effectiveness of that decision hinges on individual financial situations.
If you have a home loan, then it is probably the biggest financial commitment you have made. The home loan tenures can be 15 years or more, depending on the equated monthly instalments (EMIs) you can pay. For a long-term loan, the EMI is lower, but the interest outgo is higher. So, paying off the loan earlier makes sense, as you will pay less towards interest, and if paid in one go, you are free from the shackles of debt.
For a floating rate loan, there are no prepayment charges for a home loan, but there are other things you must consider to make an informed decision.
"There isn't a one-size-fits-all answer. Consider the following factors before deciding to prepay your home loan," says Raj Khosla, founder and MD of MyMoneyMantra.com.
●Financial Situation: If you have extra funds and are looking for places to invest, compare the returns from potential investments against the interest rate on your home loan. Investing in an asset that offers a higher return might make sense. If not, prepaying the home loan could be a good idea.
●Loan Terms: Check for any prepayment penalties associated with your loan. This can sometimes deter prepayment.
●Future Goals: If you have near-future goals that require capital, like starting a business or pursuing further education, retaining liquidity might be more beneficial.
●Peace Of Mind: For some, being debt-free offers a psychological benefit that is hard to quantify. This peace of mind might make prepayment a preferred choice.
"The decision to prepay a home loan is subjective and depends on various factors. It's advisable to consult with a financial planner or advisor to make an informed decision based on your unique circumstance," says Raj Khosla.
"The primary advantage is that you'll save on interest. Since interest on home loans is calculated on the outstanding balance, reducing this balance early on can lead to significant savings," says Khosla.
Also, paying off your loan earlier through prepayments offers the advantage of a shortened loan tenure, which is especially valuable as you approach retirement or significant life milestones where debt-free is a priority. Additionally, this strategy enhances your property ownership by accelerating the accumulation of home equity. Settling the loan ahead of schedule allows you to increase your ownership percentage in the property faster, ultimately bolstering your financial position and investment in the property.
One of the technical advantages of prepaying a home loan is that it decreases your credit-utilisation ratio. "Income loss due to accident, injury, or even devastating global issues such as war or the recently experienced pandemic can result in a financial setback for the family. During this time, one may fall behind on the EMIs. If prepayment is done, such financial adversities become less distressing without the EMI burden," says Arijit Sen, a Sebi-registered investment advisor and co-founder of Merry Mind, a Kolkata-based financial advisory firm.
There are a few cons also. "The money used for prepayment could be invested elsewhere to earn higher returns, especially if the home loan interest rate is relatively low. Also, repayment can reduce your liquid assets. It's important to ensure you have an emergency fund or liquidity for other potential needs before choosing to prepay," says Khosla.
Also, Sen adds that prepayment of a home loan would mean you need to forgo the tax benefits under section 80C and especially under section 24B. "The peace of mind gained from prepayment of home loan would ideally mean a lot more than the tax benefits forgone," says Sen.
Prepayment of a home loan can be one of the short and medium-term goals in one's life. "It may make absolute sense to prepay the home loan at the initial years as interest component is higher then," says Sen. When the loan burden decreases, you are not only saving on the interest cost, but you can focus on other commitments and goals in life, so prepayment of a home loan can be a wise option when done after considering the various pros and cons.