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Should you prepay your home loan? Factors to consider

Here are a few factors that you should consider before making the final decision:

Prepayment penalty    

Some banks charge as much as two percent as penalty for repaying the loan ahead of schedule. This fee makes prepayment appear economically unattractive. A penalty actually increases the effective rate of interest paid on a loan in case of prepayment. Explore if you can negotiate and bring down this penalty.

Partial repayment    

Borrowers struggling with high EMI payments can consider this option. Partially repaying your loan brings down the outstanding balance and consequently reduces the EMIs due. Some banks do not charge a penalty for partial repayments up to a certain amount. For example, a few banks allow partial prepayments 3-4 times a year, subject to an overall ceiling of 25 percent of the outstanding loan amount.

Emergency fund    

Do you have an emergency fund to bail you out of unforeseen contingencies? One must set aside a small portion of money towards a contingency fund at regular intervals. An accident or a temporary job loss can strike at any moment. It is very difficult to borrow money again.


   Hence, before even you consider the prepayment option, invest money so that it can be liquidated easily for unforeseen contingencies.

Clear high interest loans    

If you have surplus funds, clear other high interest debts like credit card, car and personal loans before shifting focus on your home loan. If a borrower is unable to make regular repayments on high interest debts, they could pile up quickly dragging him into a debt trap.

Refinancing    

To deal with high interest rates, some borrowers switch to banks lending at lower interest rates. Refinancing at a lower rate with another lender will involve two charges. One is the penalty to the existing lender and the other is processing fee for the new lender.


   Prepaying a loan entirely could be a better option if the sum total of charges of refinancing is very high. Prepay before you switch. This brings down your loan outstanding and consequently lowers the penalty for the switch.

Use windfall    

Prepayment is an ideal option if you have received unexpectedly a huge inheritance or a big bonus. By prepaying a loan ahead of schedule, a borrower saves substantially on interest or cost of the loan. Low or no prepayment penalty could make the option better for a borrower.

 

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