Many of home-loan borrowers are under a dilemma after they are able to accumulate some cash, whether to prepay home loan or to deploy the surplus funds in some other investment products. The answer for such question cannot be a ready-made and has to be tailor made for each one depending on factors like mind-frame of the borrower and ability to deploy surplus funds fruitfully elsewhere. Let us discuss the criteria which you should evaluate while taking such decision.
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Future needs of money in future
Before you take the decision to prepay your home loan, it is necessary that you make an assessment of money required in near future to meet various needs like education needs of your children etc. Since home loan is the cheapest form of borrowing and in case you need to go for any loan, to meet your future requirement, the cost of such borrowings will be at hugely higher say around 12%-15% for personal loan or gold loan as against 7% annual rate of interest which you pay presently for your home loan.
The present pandemic situation also has its huge impact on assessment of your future needs. Since the time frame within which we will be able to come out of Covid-19 pandemic is not easy to predict and you are not sure whether you will be able to retain your job or will be continued to be employed at the present salary, you need to make a conservative assessment of the situation and better make extra provision in the form of emergency fund. I suggest you to make a contingency fund to cover expenses for 12 months instead of 6 months which is generally recommended in normal times. The employment situation is so bad that no one can say with certainly whether he will be able to survive the pandemic unscathed financially. Even if you are self employed, the impact on your income is not yet over. So you have to be extra conservative in assessing the future scenario and conserve cash.
Tax benefits available for home loan
Though no one buys a house just for the purpose of save taxes but it is a fact that your home loan certainly helps you save taxes and you should certainly evaluate the impact of making part or full prepayment on your overall tax liability.
A taxpayer is allowed to claim two lakhs of interest for self occupied property but can claim full interest for let-out property. The ability of taxpayers to leverage their tax liability with home loan, has come down significantly after the income tax laws have been amended to provide for a cap of two lakhs rupees beyond which loss under the house property income (for all properties taken together) cannot be set off against other income of current year.
Charges payable to the lender for prepayment
The lenders may charge you certain fee in case you wish to prepay your home loan either partly or fully before it original tenure. Whether the lender will charge you for such prepayment or not will depend on whether you have taken the home loan from a bank of from a housing finance company and whether the home loan is under fixed rate or floating rate. For example the housing finance companies are not allowed to collect any prepayment penalty if the borrower is closing the home loan without taking another loan. However the bank may still charge you for prepayment. Some banks allow you to prepay upto certain percentage of your home loan outstanding at the beginning of the year without attracting prepayment penalty. So evaluate the cost of prepayment charges while taking the final decision.
Alternative Investment Avenue
The simple rule- If you think you will not be able to generate better post tax returns than what you are presently paying for home loan, prepay the home loan immediately. Since the home loan is a product of long tenure extending upto 20-30 years, one has to evaluate returns of other alternatives for equally long period. The comparison should not be made with returns offered by products like fixed deposits etc. If one goes by the historical returns of equity for past 40 years, the Sensex has generated returns of around 15% on annualised basis. So those of you who have risk appetite and also the ability to take risk-in case you are below 40-you can start investing in reputed equity mutual funds schemes for the balance tenure of your home loan. In all probability, you will be able to earn more money on your investment in mutual funds than the interest which you will be paying on home loan. This makes sense even if the balance home loan tenure is more than 7-10 years. You need to compare post tax rates/returns of both to arrive at comparable numbers.
Family pressure and Psychological reasons:
Sometimes your family members may pressurise you to foreclose your home loan as soon as it is possible, especially those who are from old school of thoughts, who do not wish to have any loan on their head for the house. They want their house to be debt free. Trust me this single reason constitutes significant proportion of the cases in India where the home loan is fully closed before its original tenure.
The writer is a tax and investment expert and working as Chief Editor of ApnaPaisa
Author Bio
A careful calculation taking into consideration of tax exemptions versus income from investing the amount proposed to be paid for foreclosure is needed to assess the profit of the method to be adopted. further, keep in mind the fact that money depreciates whereas property appreciates.. For example when I bought my house from Housing Board my EMI was Rs.900/-. p.m way back in 1980. My grand pay was 910/-. Well with my wife’s income we survived. The cost of the house at that time was 1.50 lakhs. After 20 years my pay was 22,000/-and EMI was 900/- when paid the last instalment and the house was valued in the market for 3.00 Crores.
OFFhand
Calls for a decision to foreclose , in a case to case basis; especially in a case in which there is a ‘roll-over investment’ involved, for avoiding or reducing the CGT on ‘transfer of an ‘old asset’ – ‘Charges payable to the lender for prepayment’ or the other considerations mentiined need not be the detterents to be factored in on a stand alone basis< Any thoughts to add value ?!?