We’ve just wrapped up Diwali. It’s possible the festive season brought you a windfall of some bonus income or other financial gifts. You must now be wondering how to put your gains to use. If you have a home loan, you may consider using your bonus income to make a principal prepayment. In this article, we will discuss some thoughts related to prepayment.
When to PrePay
3 questions to ask when you are looking to pre-pay​
Where are you in your loan tenure? If you’re in the first half of your loan tenure, your EMI would be more interest-heavy. A prepayment here (equivalent to at least one EMI) could help reduce your interest outgo considerably in the long term. It can also considerably reduce your loan tenure.
Where are the interest rates today? You can take a macroeconomic view of the situation today. Interest rates have been trending downwards for over three years now. This bottoming out of the interest rate presents a window of opportunity. You can exploit it by making a prepayment to reduce your loan balance at lower rates, thus ensuring heavy long-term savings.
What is your opportunity cost? Suppose you have surplus funds today. You want to decide whether it’s better for you to prepay on your loan or to put it in a fixed deposit. Let’s say the fixed deposit pays 6.5% while your loan rate is 8.5%. It may then be better to focus on clearing the loan rather than going after
a low-return.
When not to PrePay
The following conditions may not favour prepayment.
When you are almost towards the end of your loan tenure: Let’s say you’re in the last quarter of your tenure. By now, you would have cleared a large portion of your interest payments and are now repaying your principal heavily. At this point, your savings from a prepayment would not be much.
When you are nearing the end of your loan, you would gain more by not prepaying on it. With your EMIs, you can continue earning tax deductions under Sections 80C and 24B. By reducing your balance, your tax deductions for the subsequent years would also reduce.
Take stock of the interest rate you are paying on your loan. Today, many lenders are offering home loans at around 8.30 per cent. It is possible that you are paying above this rate. It is possible that your lender has not transmitted the RBI-mandated rate cuts to you. In such a case, you should consider transferring to a loan at a lower interest rate. Making a pre-payment after this transfer would have far greater impact on your loan repayment. You can approach your lender and enquire about loan transfer options. This may involve some processing costs and balance transfer fee. You also have the option of transferring your loan to another lender.
You anticipate high returns from another investment avenue. This condition can also be seen in tandem with the three above. Let’s say you’re looking to invest in the equity markets and you’re also nearing the end of your loan tenure. In such a case, you are better off investing.
— The writer is CEO, BankBazaar.com.
