A home loan is a secured loan. Therefore, the interest rate on a home loan is quite competitive as compared to other loans such as personal loan, commercial loan etc. In case of surplus funds available, it is advisable to make a thorough analysis of the returns expected from alternative investments vis-a-vis making a prepayment on the home loan account.
A prepayment on a loan will reduce your cash reserve as you cannot access that funds used for the prepayment in case of need. In addition, a home loan enables you to save a significant amount of money in income tax. If the home loan is closed, the tax saving will not be available too.
WHEN TO CONSIDER PREPAYMENT
A home loan is a very attractive lowcost loan for wealth-building, and it opens up many avenues for you to save on income tax. Therefore, pre payment of a home loan should be considered after evaluating various aspects of personal finance.
You should consider prepayment when your home loan burden is high with respect to your repayment capacity or if you are stuck with a high interest rate loan and are looking to switch the lender or sell the property.
Some people plan to prepay a home loan in case of increased earning or accumulation of surplus funds. In case of surplus funds, it is advisable to evaluate alternate options available for its deployment first. If the returns expected from such alternate investments are similar to what you are getting in terms of tax benefits against your home loan, it is advisable to deploy the surplus funds in those investments and continue with the home loan to avail the tax benefits.
In case the interest rate on your existing loan account is significantly higher than the ongoing market rate, you can consider the option of switching the home loan from your bank to another one. However, you should take a well thought-out decision after considering the various costs associated with switching the lender. For example, loan take-over cost, new loan processing fee, documentation charge etc.You should compare the total cost of these upfront expenses against the amount of savings in terms of lower interest rate.
As a thumb rule, switching to another lender is worth considering when the interest rate difference is at least 1.50 percent or more.
FUNDING A PREPAYMENT
The prepayment of a home loan is recommended in case you find it difficult to pay regular EMIs and manage your monthly cash flows. For those struggling to pay their EMIs, it becomes difficult to generate funds to make a prepayment.
It is important to note that according to regulations, banks do not charge a penalty on prepayments in case you prepay through your own means.Here are some ways to generate funds to prepay and reduce your home loan burden: Borrow from personal sources: You can borrow some funds from friends or relatives, or avail your employer’s financial support to generate the funds for a prepayment.
Exit stock investments: Since the markets are on a high, you can generate some funds by exiting from equitybased investments or taking a loan against them in case liquidation of the instruments is not possible.
PF, insurance: You can look at taking a loan against your Provident Fund or insurance policies to generate the funds for a prepayment.