When should you consider prepaying your home loan? MintGenie explains

The early bird gets the worm

The decision to prepay your home loan isn’t just about having surplus cash; it’s about timing. Making additional payments towards your home loan in the initial years can significantly impact the interest you pay over the loan’s life. For instance, Ankush, who took a ₹50 lakh home loan at 9% interest for 15 years, stands to pay ₹43.4 lakh in interest if he sticks to the scheduled payments.

Also Read: Don’t get tripped up! 8 common home loan myths debunked for savvy borrowers

Amortisation schedule for a ₹50 lakh loan at 9% p.a.

In Ankush’s situation, he initially paid ₹4.5 lakh as interest in the 1st year. This amount gradually reduces to about ₹2 lakh by the 11th year of the loan period.

Should Ankush stick to the regular payment schedule without adding any extra amounts, he’ll end up paying a total of ₹43.4 lakh in interest, besides repaying the principal amount of the loan. However, if Ankush decides to make additional payments of ₹5 lakh each during the 2nd, 3rd, and 4th years of his loan, he could achieve substantial savings. Specifically, Ankush would save ₹16.38 lakh in interest and could reduce his loan period by almost 3 years.

Choosing to make these extra payments a bit later, between the 5th and 7th years, would still result in savings but to a lesser extent; Ankush would save ₹12.33 lakh in interest and see a similar reduction in his loan duration. Making the same prepayments between the 8th and 10th years would lead to even smaller savings, at ₹8.28 lakh. Thus, the strategy suggests that making additional payments earlier in the loan tenure is more beneficial. The sooner, the better.

Also Read: Loan default: Struggling to repay your loan? Understand borrower’s rights

Tax benefits

The government offers tax deductions on home loan interest (up to ₹2 lakh under Section 24) and principal repayment (up to ₹1.5 lakh under Section 80C). These deductions make the loan more manageable but also add a layer of complexity to the decision to prepay. If you’re in the highest tax bracket, keeping the loan until your interest falls below ₹2 lakh makes sense, optimising tax benefits while reducing interest outlay.

However, co-owners, such as a couple with a joint loan, can claim higher deductions.

Prioritise an emergency fund

An emergency fund is your financial safety net, crucial for tackling unexpected life events without derailing your finances. Before considering prepayment, ensure you have a robust emergency fund in place.

Long-term financial goals shouldn’t suffer

While the allure of a debt-free life is strong, it’s essential not to lose sight of other long-term financial goals, like retirement. The interest rate on your home loan, especially after accounting for tax savings, is often lower than the returns you could achieve through investments aimed at these long-term goals. For instance, equities, which form a core part of retirement portfolios, can potentially offer higher post-tax returns than the effective cost of your loan.

Also Read: Home loan for under-construction property: Will I get income tax benefits?

The devil is in the details

Before you decide to prepay, familiarise yourself with your lender’s policy on prepayment. Some loans, especially fixed-rate ones, may come with prepayment charges, while floating-rate loans usually do not. Knowing these details can help you avoid any unwelcome surprises.

Also, remember that no amount is too small for prepayment. Even modest sums can contribute to significant savings on interest over time.

Final thought

Paying off your home loan early can save you on interest and help you own your home faster. But it’s important to balance this decision with your other financial goals and plans. By thinking about the best time to make extra payments, taking advantage of tax breaks, having an emergency fund, and not losing sight of long-term goals, you can make a smart choice that fits your overall financial health.

So, when you’re looking at that extra cash in your bank, remember that early loan payments could bring big financial benefits and help you live a debt-free life in a smart and rewarding way.

Chakrivardhan Kuppala, Executive Director and Co-founder, Prime Wealth Finserv Pvt Ltd.

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Published: 16 Apr 2024, 10:57 AM IST