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Owning a home is a dream for many, but a home loan is a long-term financial commitment that can span several years.
Given rising living costs, prepaying your home loan can be a strategic move to reduce your debt burden. It could help you save on total interest costs over the long term and potentially repay your loan sooner.
However, before opting for partial or full prepayment, it is essential to evaluate factors such as your financial stability, the possible impact on tax benefits, and any prepayment penalties that may apply.
Let us discuss how prepaying your home loan impacts your Equated Monthly Instalment (EMI) and tenure, along with its advantages and drawbacks, to help you make an informed decision.
What Happens If You Prepay Your Home Loan?
When you make a part payment towards your home loan, it directly reduces the outstanding principal amount. This, in turn, lowers the interest burden on the remaining amount, which can lead to significant savings over time.
Reputed lenders such as SMFG Grihashakti provide an online, free-to-use home loan prepayment calculator to help you estimate potential interest savings. To calculate the benefits of making a part-prepayment, simply enter your original loan details, including the loan amount, original loan tenure, interest rate, and number of EMIs already paid, into the home loan prepayment calculator. Then, enter the prepayment amount and revised EMI amount, and click ‘Calculate’ to see the interest savings you can gain from making a part-prepayment on your home loan.
However, keep in mind that the calculator does not account for the impact of any value-added services (e.g., insurance), prepayment penalties, late payment fees, and so on.
After a part-prepayment, depending on their internal policies, lenders may offer you the option to either reduce your EMI or shorten the loan tenure.
A lower EMI would reduce your monthly payment burden, making it easier to budget for essential household expenses and other short-term obligations. On the other hand, a shorter tenure may increase your EMIs, but could help you repay the loan faster and lower overall interest costs. This would allow you to allocate more funds towards long-term financial goals or investments.
Factors to Keep in Mind When Opting for Prepayment
Prepaying your home loan can be a sound strategy, but you should consider these key factors before proceeding:
- Emergency Funds: Ensure you have enough savings for unforeseen expenses before using surplus funds for prepayment.
- Tax Benefits: Home loans offer tax deductions on both the principal and interest components under Sections 80C and 24(b) of the Income Tax Act (under the Old Tax Regime). Prepaying the loan may reduce or eliminate these benefits.
- Other Loan Commitments: If you have high-interest debts, such as credit cards, it may be more beneficial to clear them first before prepaying your home loan.
- Prepayment Penalties: Fixed-rate home loans often come with prepayment charges, which can vary from lender to lender. However, financial institutions cannot levy these charges on home loans with floating rates of interest taken for non-business purposes, according to the Reserve Bank of India (RBI) guidelines.
Sources of Funds for Home Loan Prepayment
You can prepay your home loan using various sources of funds, such as:
- Bonuses or incentives from your job
- Savings from monthly expenses
- Rental income
- Inheritance or monetary gifts
- Windfall gains such as asset sales
- Maturity proceeds from insurance policies, Fixed Deposits (FDs), or other investments
Pros and Cons of Prepaying Your Home Loan
Pros:
- Potential significant interest savings over the loan tenure.
- Can help you close the loan earlier and achieve financial freedom.
- Reducing outstanding debt can increase your credit score and improve your eligibility for future loans.
Cons:
- Potential loss of tax benefits that could increase your taxable income.
- Using a considerable portion of savings for prepayment may leave you with limited emergency funds.
- Any applicable prepayment penalties may offset potential savings on the interest costs.
Conclusion
Prepaying your home loan requires careful evaluation of your financial health, goals, and available resources. While it can lead to substantial interest savings and early debt repayment, it should not come at the cost of compromising your emergency funds or other financial priorities.
To make an informed decision, use an online home loan prepayment calculator and consider consulting a professional financial advisor. The prepayment should ultimately align with your long-term financial strategy and overall well-being.
*Prepayment calculators only tell you an estimated figure. The actual effect of prepayments will depend on several factors, including the lender’s policy at the time of the application.
