Friday, 12 May 2017

Pros and cons of prepaying a home loan

The wish of buying a dream home becomes a reality when you get a home loan of your choice. Home loans are essential types of loan in which both banks and consumers are interested in. Being the long term loans, they stay in your CIR for longer period of time, significantly affecting your credit worthiness.
So, when you plan a home loan it is advisable to read the terms related to prepayment option along the interest rate and loan duration.
Whether you apply for HDFC home loan, SBI home loan or the one from PNB, all banks offer you prepayment option. Sometimes banks charge 2-3 % of fee for opting for prepayment in the middle of the loan tenure.
The prepayment of loan is a win-win situation for you as it would improve your credit score and you would get rid of a debt sooner. While for the bank, it would entail an added burden of finding out another client to lend the amount being credited to them before the anticipated time. They might even discourage you to opt for prepayment option and thus many lenders choose to levy a fee or penalty for the same.
So, let’s weigh down the pros and cons of prepayment of home loans so that you could now if you need to prepay your current home loan.
The Pros:
When you go for prepayment, you get rid of debt early. It improves your credit score and you regain the power of availing credit again. So you get more financial flexibility as you repay.
Next, prepayment of a home loan is basically an investment option. Let’s understand this with a simple example.
Mr Subodh Gupta has a home loan of Rs 12 lakhs at interest rate of 10 percent per annum for 10 years. Every month he pays 10,000 of EMI. After paying EMIs for first 12 months, he receives an annual bonus of Rs 1 lakh this Diwali. He has an option to either keep it in a bank account, invest somewhere or have a fixed deposit. Each of these option will fetch him between 6-8 % interest rate.
However if he decides to prepay, he is cutting the principal amount for larger interest and yield greater benefits. So he decides to pre-pay the loan. His remaining loan principle would be 10 Lakh and 10 % on lakh would be 1 Lakh of interest. Had he not opted for prepaying the dues, his pending interest would have been 10 % on 11 lakh which is 1 lakh and 10 thousand. So he has saved 10% (Rs 10,000) interest by repaying.
So, by prepaying the loan one can either choose to reduce the duration of the loan or reduce EMI. In the above example, by retaining the same EMI, Mr Subodh would reduce the loan duration for 1 year.
However if he has other expenses to fund, he should choose to reduce the EMI. This way loan would run for the same duration but additional saving per month on EMI can be used to fund the other short term expenses.
Thus by prepaying the loan you basically plan other credit lines and add to your financial sturdiness.
The Cons
With home loans you avail certain tax benefits under Section 24(b) and Section 80EE.By prepaying the loan, you may miss those benefits. You get tax deduction up to Rs 1.5 lakh per annum. So it is advisable to make partial prepayment and keep availing these benefits at the same time.
If you use all of your cash or savings by prepaying, you may end up sucking up funds for emergency. Thus, prepayment should be an option and not the necessity for you.
Being lesser expensive loans than other loans, you should prepay other expensive loans first.
Many banks levy penalty on prepaying so you should check out the impact of those charges on your loan before making the decision.
Things to keep in mind when you plan the prepayment:
Never prepay the entire loan amount. You only need to pay out till the time you save on interest amount on the loan.
As cutting on to the interest is your basic aim of prepayment you should plan the pay out in the early stage of the loan.
When you want to prepay, the bank would ask you submit certain documents such as ID, address, and income proof. So be prepared with all the required paper work.

Last but not the least, you should use a Home Loan Prepayment Calculator before making the decision.

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