Balwant Jain
Generally when a person taken home loan, he takes into account his current income and accordingly applies for the loan based on the then eligibility. However with income going up the borrower generally accumulates some surplus. Such borrowers face the dilemma what to do with the surplus funds. Should I prepay the home loan or should I invest the money somewhere else. The answer to this question will depend on various costs and benefits involved in prepaying your home loan. Let us understand all the factors which affects your decision to prepay your home loan.
Cost of prepaying home loans:
The lenders generally charge some prepayment charges for you prepaying any home loans. The quantum of such charges is dependent on the agreement executed by you with the lender. Such charges normally vary between 2% to 4%. Some of the lenders do not charge you any prepayment penalty. As per a circular issued by the National Housing Bank which governs all the housing finance companies, the housing finance companies have been advised not to levy any prepayment penalty on home loans under floating rate regime. Even in case of fixed rate home loan even if the borrower has repaid the loan from its own resources, the housing finance company can not charge any prepayment penalty. Likewise the RBI has also advised all the banks not to levy any prepayment penalty on all the loans taken under floating rates. So in case you have taken home loan under fixed rates, the banks can still charge you prepayment penalty even if you prepay the home loan from your own resources.
One can prepay the loan fully or partly depending on the funds available. Lending institutions normally do not charge any prepayment penalty if the amount prepaid does not exceed 25% of the loan outstanding at the beginning of the year. So in case you are prepaying partly within the limit of 25% you can do so without having to pay any penalty.
Tax considerations:
The decision to prepay the home loan is equally dependent on the impact of such repayment on your eligibility to claim interest deduction under Section 24(b). In case the property is self occupied, you are allowed deduction only upto Rs. 1.50 lacs of interest. So in case any part prepayment does not bring down the amount of interest below 1.50 lacs, it will not have any impact on your tax liability. However in case the property is let out, the decision would be different as entire interest payment is tax deductible. So evaluate the tax impact due to reduction in interest payment.
Funds requirement in future:
You should take the decision to prepay the home loan only after taking into account the requirement of funds in next future for any purpose including contingencies. So your decision whether to prepay and how much to prepay should be based on both these consideration because the home loans are available at relatively cheaper interest rates than other loans like personal loans and gold loans. In case you need money in future after having prepaid the home, you may have to borrow money at far higher rate of interest whether in the form of gold loan or personal loan.
Returns expected from alternative investment avenues available:
While evaluating the option of prepayment of the loan, please consider the alternative options available for deployment of your surplus funds. In case the returns expected on such investments are similar it is advisable not to prepay the loan. One such alternative avenues available for investment is Bonds being issued by NBFCs. The other alternative may be investing the money in equity oriented funds in case the money can be invested for more than 10 year as the returns on equity oriented funds have been generally good for such long tenure.
So there are many factors which you need to evaluate while taking the decision of prepayment of your home loan. However there is one psychological factor which is equally important in this case. People of old school of thought do not want to have any debt on their place of residence and this psychological reason plays its role in substantial numbers of cases.
So decision is yours whether you belong to old school of thoughts or to new school of thought.
(Balwant Jain is a CA, CS and CFP. Presently working as Company Secretary of Bombay Oxygen Corporation Limited. He can be reached at jainbalwant@gmail.com)
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Nice explonation sir.