Prepay Your Home Loan - The Smart Way
PAYING off that home loan through monthly EMIs (equated monthly instalment) is perhaps the biggest financial commitment that an individual can make in his life. And spiralling property prices coupled with hardening interest rates are not making that burden any lighter as borrowers stare helplessly at EMIs eating into a major part of their take-home salaries.
No wonder, most people are forever looking for ways to prepay a part of the loan as early as they can. In fact, many bankers will tell you that most Indians prefer to pay off loans — even if they have a tenure of 15 or 20 years — within 10 years. Though many a time the aim may be to buy a bigger house, the fact remains that most people prefer to prepay their home loans as they abhor the idea of a huge EMI sitting on their monthly bills.
However, making a case for early repayment or prepayment is a difficult proposition. One the one hand, a housing loan helps you to create your own space and, on the other, it also offers you tax breaks — both for paying off the interest and principal payment. But a home loan comes with a huge price tag. For instance, if you take a loan of 50 lakh at 10.5% for 15 years, the total interest cost alone will work out to a whopping 4.95 crore. However, you cannot categorise a home loan as a bad loan, as it helps you invest in a property which may fetch you higher returns in future. Nonetheless, you can significantly reduce the interest cost by prepaying the loan — provided, you have some surplus in the bank.
Part or Full Prepayment?
If you plan to prepay the housing loan you have two options. Under the full prepayment option, you need to cough up a huge sum so as to be able to pay off the dues. If you don't have such a huge kitty, you can consistently make part-prepayments, say every quarter, or a year depending upon your comfort level. This will reduce the principal amount and bring down the outstanding loan amount and the net interest outgo. The longer the loan tenure, higher the amount of interest repaid. Banks will usually cap your maximum EMI at around 50% of your current monthly income. But you should ideally borrow only up to 40% of your take-home salary so that you have some leeway to pay off dues ahead of time.
Plan Your Prepayment In Advance:
You should not be an overleveraged borrower. You should have spare cash for disciplined investment. Finally, you may have to cut down on your lifestyle for the first few years if you have to keep aside additional money. But if you want to pay off your home loan faster, then you have to follow certain steps.
Use SIPs & RDs As Backups:
This is a disciplined form of investing your surplus cash. The idea is to build a sizeable corpus over a period of time. You could open a recurring deposit (RD) with a bank or a post office. In case of banks, you can earn a return of around 6% but you have the flexibility in choosing the tenure of the RD. The post office, on the other hand offers 8% on RDs but they come with a lock-in of five years. Alternatively, you could look at SIPs in debt funds if you are looking at a 3-4-year period. For anything beyond five years, you could look at SIPs in equity-oriented mutual funds. Unlike an RD, a borrower can stop his SIP half way if he is unable to cough up the money. But you should strictly look at SIPs in debt products and liquid-plus categories.
Go For Easy-Exit Instruments:
It's crucial to lock into instruments with an easy-exit clause. Liquid funds and liquid-plus funds can come in handy to park your short-term gains and help you earn a return of 4.5-5%. These instruments offer twin benefits of liquidity and returns.
Save Up Part Of Your Bonus:
You could earmark a certain portion of you bonus or the entire bonus to partly prepay the housing loan. This will bring down your principal amount and bring down the interest costs significantly. However, use the entire bonus towards the home loan repayment only after meeting the expenses and investment needs for your long term financial goals. The logic is that a home loan is a good debt because it is used in creating an asset and also offers tax benefits on the loan.
Step Up Your EMIs:
This is a common option exercised by borrowers. But it's not the best way to pay your loan faster. If you are paying a lump sum amount, it has a direct impact on the principal amount. It simply means repaying the principal back to the lender and it is straight forward. Even if you pay by way of increased EMIs, after the interest cost (which is constant) the balance will go towards servicing the principal. But then, this is not as clear cut as directly paying off the principal. If you have got a salary hike, it is better to park the surplus money in an RD/SIP/liquid fund as stated above and pay off after earning some return on it.
Pay One EMI Before Schedule:
Usually there is a month gap between the loan disbursement and the first EMI. Any payment you make in this period is directed towards payment of the principal and reduces the overall interest cost.
Choose A Home Loan That Suits Your Needs:
If you are clear about settling dues at the earliest, then look for a scheme that allows maximum part prepayments in a given year. For instance, some banks allow such payments once a year whereas some banks allow payments 3-4 times a year, subject to an overall ceiling of 25% of the outstanding amount. Similarly, many banks offer home-saver loans in which you have to pay interest only on the utilised amount rather than the entire disbursed amount. In such loans, a current account is linked to the loan account. For example, if you maintain a balance of 10 lakh in the current account, you have to pay an interest on 30 lakh even if the actual loan amount is 40 lakh. You can keep stepping up this balance in the current account and withdraw it whenever in need of money. The interest rate is adjusted accordingly.
