A person’s biggest financial debt is usually a home loan. It’s no surprise, then, that many desire to pay off their loans as quickly as possible. A home loan EMI becomes more burdensome during times of economic instability, job losses, and wage cuts. You may be intending to take out a home loan at the same time, with interest rates at record lows. It’s also crucial to understand the prepayment regulations in such a circumstance. Only after carefully weighing all of the benefits and drawbacks should you decide to repay a loan.
What is home loan prepayment?
Borrowers with a home loan might save money by prepaying their loan. It aids in the reduction of interest load and, as a result, the overall cost of the property. Any sort of debt, including a home loan, is bad for a person’s financial health. Because the average tenure of a home loan in India is 8 years, borrowers tend to pay off their home loans early.
Part-paying a home loan is one of the finest ways to use any extra cash or windfalls, such as bonuses, inheritances, or financial gifts, to good use. As a result, the availability of such cash may be a factor to consider while part-paying your home loan. In fact, because floating rate home loans may experience a hike due to interest rate revisions or a significant drop in the borrower’s credit score at any point during the loan term, it may be a good idea to make as many part-prepayments as possible while the applicable home loan interest rates are low and your credit score is high.
Cost of prepayment
Prepayment penalties are not charged by banks or housing finance companies (HFCs) on floating rate home loans. A tiny fee for simple interest will be charged, which can be reduced by completing the prepayment early in the month. In fixed-rate home loans, however, lenders may charge a prepayment penalty of roughly 2% of the amount prepaid.
How much to prepay
Some lenders restrict part-prepayment of home loans if the prepayment amount is less than a specific threshold. To make a part prepayment, most banks require a sum more than the current EMI. To make a part prepayment, several banks and financial institutions require at least three times the EMI amount. So, before you decide to make a partial prepayment on a house loan, be sure you understand all of the terms and conditions.
When should you avoid prepayment?
In most circumstances, it is preferable to pay off the debt in order to save money on interest. However, there are several circumstances in which you should avoid prepayment and instead continue to service the debt. The following are examples of these scenarios:
The prepayment penalty is more than possible savings
Prepayment costs of 1% to 5% are imposed by banks on loan prepayments in order to reclaim some of the interest losses incurred as a result of the prepayment. This penalty may also serve as a deterrent to individuals who wish to make prepayments. As a result, you must perform a cost-benefit analysis in terms of prepayment charges, and if the charges are greater than the savings, stick to the EMIs.
Transfer your home loan balance to a lender with a lower interest rate.
Financial institutions offer the option of moving loans to another institution (with some penalties) if the latter’s interest rate is lower. It’s a good idea to estimate the entire savings by utilizing an online home loan balance transfer calculator, and if the figures look promising, transfer the loan at the new bank’s lower rate to take advantage of the reduced rate.
Better options to utilize the spare cash
If you have extra cash as a consequence of a recent windfall, prepaying your debt seems like a good idea. In this instance, you should look for a better way to spend the money before paying off the loan. If you have an investment opportunity that offers superior returns, invest in it instead of paying prepayment.
Prepayment during later phase of loan tenure
In the early stages of repayment, all banks levy their interest component. When looking at the repayment plan, the principal component is low in the beginning and increases as the term progresses. Prepaying a loan that is near to being paid off makes no sense because most of the interest payments have already been made, and the current EMI charged is primarily covering the loan principal. In such instances, it is preferable to forgo prepayment and instead invest the funds in more profitable ventures.
While prepaying a home loan to become debt-free is desirable, it should not come at the expense of your other financial goals, such as an emergency fund, a fund for your children’s education, or retirement plans. Always remember that your efforts to secure the finances needed for home loan part-prepayments shouldn’t leave you subject to life’s uncertainties or cause you to miss out on other vital financial goals.
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