Owning a home brings pride and satisfaction, but it is also the biggest financial obligation for the individual. The flurry of rate hikes by the RBI has pushed up home loan rates from 6.5% to 9% in the past 15 months. A 20-year home loan taken in April 2022 at 6.5% will now have to be repaid over 30-32 years. However, one can reduce this tenure through partial prepayments.
The home loan repayment journey can be broken into four stages. Prepayment in the early stages of the loan reduces the interest burden more effectively.
PHASE 1
Applying for home loan
A home loan is a long-term financial commitment of 10-25 years. Choose the right tenure and banking partner at this stage.
. Customers often opt for longer tenures to keep the EMI low, but longer tenures also mean higher interest outgo. Ideally, go for as short a tenure as possible.
. Try to make a bigger down payment. If you have taken a loan of Rs.50 lakh at 8% for 20 years, you could save over Rs.6 lakh in interest over the loan tenure by increasing your down payment by Rs.5 lakh.
. Home loan rates depend on multiple factors and every lender follows its own policy framework. Magicbricks’ proprietary Bank Recommendation Engine compares more than 40 banks and recommends the best option among them.
PHASE 2
20% tenure complete
At this stage, the interest component is still 60-70% of the EMI, so prepayment of the loan is a good idea. Use direct windfall gains and other surplus cash to pay the outstanding loan. Opt for reduction of tenure instead of slashing the EMI. One can substantially save on interest payouts in this manner.
. Increase the loan EMI as your income goes up. For example, by increasing the EMI by Rs.5,000 on a home loan of Rs.40 lakh at 7.5% for 20 years, one can save about Rs.8 lakh in interest outgo and become debt-free seven years earlier.
. Shifting to a cheaper loan can also help bring down the interest burden. Some banks refinance the loan at a lower interest rate, which reduces the outgo.
. Keep an eye on the processing fee and other charges when you get the home loan refinanced.
PHASE 3
50% tenure complete
The principal portion in EMI goes up to 60-70%, while the interest component comes down to 30-40%.
. Weigh the options of investing elsewhere before you prepay, especially if you are claiming tax benefits on the home loan interest. In the 30% tax bracket, the effective interest paid on a loan at 9% is only 6.2%, which is comparable to the post-tax returns on corporate fixed deposits.
. If you have the risk appetite to invest in market-linked instruments, you may be better off investing rather than prepaying the loan.
PHASE 4
80% tenure complete
With the bulk of the EMI going towards the principal, prepayment does not make much financial sense at this stage.
. Surplus funds should not be used to prepay the loan, but should be invested in financial instruments that offer better yields.
. Prepay only if your considerations are beyond financial principles, such as acquiring peace of mind and becoming debt-free early.
Source By: economictimes
