Most of the young, enthusiastic workforce buy their dream home and then aim to prepay the home loan. Should you prepay or use the surplus for further investment? Looking for clarity on this question read on –
PREPAY OR REINVEST?
To understand better, evaluate the following conditions in your financial planning – When to Prepay? During initial years of Home Loan, interest outflow outweighs principal payment. Whereas towards the end of Home Loan tenure, principal payment is higher compared to the interest payment. Therefore, financially it is more beneficial to prepay home loan during first seven years assuming the tenure of the loan is 15 years (first half period of the complete tenure).
Tax Liability – If Home Loan is availed just to incur tax benefit and Income tax deductions, it is not a wise decision. Individuals should weigh the advantages of utilizing self-occupied property interest deduction benefits under Sec 24(1) or HRA tax benefit. The three situations that could help individuals in claiming interest deductions and HRA benefits are –
Individuals own their house in a different city and live on rent in another city
Individuals living in the same city, but stays in a rented house due to some genuine reason
An individual with the self-occupied property but in reality is not occupied by you, say although because of work commitment you stay elsewhere, and your family stays in a house property.
Does the tax deduction offset the EMI paid – Let’s say Kavita resides in Gurgaon on rent of Rs 30,000 per month, is eligible for HRA of Rs 45,000. Her basic salary is Rs 80,000. Kavita has taken a home loan to buy a house in Bangalore, where currently her parents are residing. The interest she pays on the loan for her house is Rs 25,000 per month. Kavita could claim for both HRA and home loan deductions as follows –
On HRA – Actual Rent Paid = Rs 30,000 40% of Basic [non-metro city] = Rs 32,000 Rent paid ~ 10% of Basic = Rs 30,000 – Rs 8,000 = Rs 22,000 Hence HRA exempt = Rs 22,000 Remaining HRA of Rs 45,000 – Rs 22,000 = Rs 23,000 Taxable
Funds for Future – Retirement planning, Childs education and above all some liquid as a contingency plan should always be available. So if the surplus available is used for the above planning and you are still left with “x” amount. Go ahead and prepay it!
Other Liabilities – Do you have any other liabilities like a car loan or a personal loan? Make sure to evaluate other liabilities before prepaying or investing.
REFINANCING MY HOME LOAN?
If RBI has announced interest rate cuts and your bank is not offering that rate to its existing borrowers, you could refinance your mortgage. However, one should consider following factors before opting for refinancing – Interest rates: The interest rate would decide your EMI, so the lower the rate the best it is. Explore out with few banks and check of rates being offered. Banks Processing charges: Many banks advertise with “zero processing fees” as a tagline, but each bank will charge you with some amount of processing fees. So, make sure to compare the amount you save versus amount you pay, if the result is quite significant, refinancing is the best solution. Floating rate versus fixed rate: Opting for refinancing to get your interest type changed is not a wise option.
PREPAYING MANY TIMES IN A YEAR OR INCREASING THE EMI?
With salary increase, an individual could opt for an increase in EMI thereby prepaying the loan amount in very small amounts or save that extra amount and pay it in a lump sum every quarter or once a year. The salary increase is also at times a result of the rise in inflation, so if an individual has decided to increase the EMI, it may put some pressure on the monthly budget. If you are already overstretched financially, it may be best to keep the same EMI for now. Saving the increment from your salary and then paying a lump sum amount could help in the following ways –
Get your financial planning right ensuring there is no interruptions in the goals.
You would always have some liquid as your contingency plan
Your cash flows would be more comfortable.
As you grow up in your career, even your salary increases, so with a higher increase salary try to accommodate more EMI, that would reduce principal and tenure leading to close loan early
Use a part of savings/ bonus in prepaying the home loan maybe quarterly or half yearly.
Plan your financials for each year; check the investments and their yields. Once you are assured that your investments are taking care of your short, medium and long-term financial goals, you can direct the surplus you have towards the prepayment of your home loan
We hope we have helped you in getting a clear picture of whether you should prepay your loan and when to do it. If you still have any unanswered questions or need help, feel free to contact us here We would be glad to help you with your planning and investment related decisions. Samiksha SethContent Strategist – Dilzer Consultants Pvt Ltd.