Skip to main content

Should you prepay your home loan?

One of the commonly asked questions in financial planning is about prepaying housing loans. While most households take along-term loan, they are keen to de-leverage and pay off the loan before the completion of the term. They associate the loan with liability, which it is, and like having the peace of mind that comes from knowing that the home they live in is theirs, with no encumbrances. Let's look at their decision as a 'financial strategy' for the household's balance sheet and evaluate the choices objectively.

The first principle is that a loan offers the benefit of leverage, while building an appreciating asset. If the loan comes at 11 per cent and the period of repayment is 15 years, the house it funds will grow at a higher rate. So, it is worth funding the house with a loan, rather than our own funds.

But what portion of the house should be funded by a loan depends on how the value of the house can fluctuate. It may not appreciate in a straight line year after year but go through phases of falling in value as well. We need to estimate that risk. If we assess that the property can fall by 30 per cent at the most when the loan is still due, this is the proportion of one's own funds that should be used. If the value of the house is dropping and the loan component is higher than its current value, a part of the loan should be prepaid to reduce risks.

The second principle is that money can always be put to alternative uses, which need objective comparison. We may be able to pay a higher equated monthly instalment (EMI) on receiving a bonus, inheritance, or any such large amount, which can be used to repay the home loan. If we are able to deploy such funds at a higher rate than what we pay on the home loan, we are better off investing.

If we are likely to leave that money in a bank deposit with alower interest rate than the home loan, we are better off repaying the loan. If we use the funds to buy a depreciating asset such as a car, we may still be better off repaying. If we choose to keep the funds in another appreciating asset, we need to be sure there is flexibility to pay off anytime we need to readjust the loans in our books. Buying another piece of illiquid land may not be a good idea, for instance.

The third principle is that risks to income and future plans impact the liability that can be carried. We are eager to repay a loan, as we see it as arisk to our income. EMI is paid even when we face an income reduction, job loss, illness or any other similar risk. We think that repaying the loan when our income is high and when our ability to save has moved up is a better option.

If the loan has to be repaid at a short notice to accommodate any other need, we worry about having to sell the house and prefer avoiding a crisis. We choose to pay the loan and own the house. To achieve this flexibility, we can either build assets or reduce the loan. To deal with the risk, we can build assets that will grow at a higher rate than the loan. We can also choose a flexible and liquid option such as mutual funds, where we can deploy the surplus, instead of repaying the loan. We clearly build the asset to offset the liability on the loan. If we need to repay the loan any time, this earmarked asset can be liquidated and the loan repaid. We can, thus, use the leverage benefit of the loan and be ready to repay, if there is a need.

View your loan as a liability against which you need assets to keep the financial position healthy. As a rule of thumb, if your assets (including the house) are twice the value of the loan, your household balance sheet is healthy to carry the loan. Use your surplus funds to build assets.

Popular posts from this blog

Am you Required to E-file Tax Return?

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300   Am I Required to 'E-file' My Return? Yes, under the law you are required to e-file your return if your income for the year is Rs. 500,000 or more. Even if you are not required to e-file your return, it is advisable to do so for the following benefits: i) E-filing is environment friendly. ii) E-filing ensures certain validations before the return is filed. Therefore, e-returns are more accurate than the paper returns. iii) E-returns are processed faster than the paper returns. iv) E-filing can be done from the comfort of home/office and you do not have to stand in queue to e-file. v) E-returns can be accessed anytime from the tax department's e-filing portal. For further information contact Prajna Capit...

IDFC - Long term infrastructure bonds - Tranche 2

IDFC - Long term infrastructure bonds What are infrastructure bonds? In 2010, the government introduced a new section 80CCF under the Income Tax Act, 1961 (" Income Tax Act ") to provide for income tax deductions for subscription to long-term infrastructure bonds and pursuant to that the Central Board of Direct Taxes passed Notification No. 48/2010/F.No.149/84/2010-SO(TPL) dated July 9, 2010. These long term infrastructure bonds offer an additional window of tax deduction of investments up to Rs. 20,000 for the financial year 2010-11. This deduction is over and above the Rs 1 lakh deduction available under sections 80C, 80CCC and 80CCD read with section 80CCE of the Income Tax Act. Infrastructure bonds help in intermediating the retail investor's savings into infrastructure sector directly. Long term infrastructure Bonds by IDFC IDFC issued an earlier tranche of these long term infrastructure bonds on November 12, 2010. This is the second public issue of long-te...

Section 80CCD

Top SIP Funds Online   Income tax deduction under section 80CCD Under Income Tax, TaxPayers have the benefit of claiming several deductions. Out of the deduction avenues, Section 80CCD provides t axpayer deductions against investments made in specific sector s. Under Section 80CCD, an assessee is eligible to claim deductions against the contributions made to the National Pension Scheme or Atal Pension Yojana. Contributions made by an employer to National Pension Scheme are also eligible for deductions under the provisions of Section 80 CCD. In this article, we will take a look at the primary features of this section, the terms and conditions for claiming deductions, the eligibility to claim such deductions, and some of the commonly asked questions in this regard. There are two parts of Section 80CCD. Subsection 1 of this section refers to tax deductions for all assesses who are central government or state government employees, or self-employed or employed by any other employers. In...

ULIP Review: ProGrowth Super II

  If you are interested in a death cover that's just big enough, HDFC SL ProGrowth Super II is something worth a try. The beauty is it has something for everybody — you name the risk profile, the category is right up there. But do a SWOT analysis of the basket, and the gloss fades     HDFC SL ProGrowth Super II is a type-II unit-linked insurance plan ( ULIP ). Launched in September 2010, this is a small ticket-size scheme with multiple rider options and adequate death cover. It offers five investment options (funds) — one in each category of large-cap equity, mid-cap equity, balanced, debt and money market fund. COST STRUCTURE: ProGrowth Super II is reasonably priced, with the premium allocation charge lower than most others in the category. However, the scheme's mortality charge is almost 60% that of LIC mortality table for those investing early in life. This charge reduces with age. BENEFITS: Investors can choose a sum assured between 10-40 times the annualised premium...

Bharat Bond ETF

Top SIP Funds Online   The government of India has paved the way for the launch of India's first corporate bond ETF called as Bharat Bond ETF. Edelweiss Mutual Fund will be managing it. The fund is mandated to invest in AAA-rated bonds of select public sector companies (see the table 'List of constituents and their proportions in the portfolio'). The government has a threefold objective behind launching this product. One, to deepen the liquidity of the Indian debt markets and provide a gateway for easy retail participation. Two, to solve investors' dilemma of picking premium bonds. Lastly, to help the underlying government-owned companies raise funding for their operations. But does it make sense for you, the investor, to invest in it? Lets find out. What is the product? As the name suggests, it is an exchange-traded fund which will be listed on a stock exchange from where its units can be bought and sold post launch. It will have two variants - one maturing in 3 ye...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now