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Consider these factors before opting for home loan prepayment

The interest cost of home loans, especially the ones with longer tenures, often exceeds the principal component. (Photo: iStock)Premium
The interest cost of home loans, especially the ones with longer tenures, often exceeds the principal component. (Photo: iStock)

  • Liquidating existing investments might push one to take up costly loans later. Thus, prepay home loan only if you have adequate surpluses after factoring in emergency funds, investments and monthly contributions set aside for your unavoidable financial goals

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NEW DELHI: A home loan, by nature, extends over several years. As a result, the interest cost of home loans, especially the ones with longer tenures, often exceeds the principal component. Most borrowers usually try to reduce their interest burden by making prepayments.

Here are four crucial factors to consider while prepaying your home loan:

Factor in your liquidity

When selecting between equated monthly instalments (EMIs) and repayment tenure reduction options, you must factor in your liquidity.

Home loan borrowers get two options when part-prepaying their home loan. They can either reduce their EMIs or cut down home loan repayment tenure. While the latter can lead to increased savings in interest payout, the decision must factor in your disposable income.

Ratan Chaudhary, head- home loans, Paisabazaar.com, said, "For instance, assume that you availed a home loan of 50 lakh about five years ago at 8% p.a. for a tenure of 20 years. Your current outstanding would be Rs43.76 lakh. If you make a lump sum prepayment of Rs6 lakh now and opt for tenure reduction, you will save about Rs11.30 lakh in interest payment, and your loan repayment tenure would reduce by 41 months. However, if you opt to continue with the same tenure assuming the same rate of interest, then your EMI would fall from 41,822 to 36,088 and generate a total interest savings of 4.32 lakh. Thus, opting for the tenure reduction option would lead to higher savings in interest cost."

Check home loan transfer option

While home loan prepayment can certainly reduce net interest cost, doing so by liquidating existing investments can effect financial health. Another alternative for reducing interest cost is the home loan balance transfer option, wherein another lender takes over the existing home loan at a lower rate. This option reduces interest payout without impacting existing investments and liquidity.

"For instance, assume that you availed a home loan of 50 lakh about five years ago at 8% p.a. for a tenure of 20 years. Your current outstanding would be 43.76 lakh. Now, suppose you transfer your home loan to another lender at say 7% p.a. for the remaining repayment tenure of 15 years. In that case, you will still manage to save about 4.48 lakh in interest cost without compromising your existing investments and liquidity," Chaudhary explained.

Therefore, compare savings derived through part-prepayment and those attained through home loan balance transfer and take a decision based on your financial goals and liquidity.

Avoid dipping into emergency fund

An emergency fund helps unavoidable expenditure. This fund's size should be adequate enough to meet mandatory expenses for at least six months.

If the fund is used up prepaying home loan, then in case of an emergency, one might need to resort to high-interest rate loans or liquidate existing investments at a loss. 

Avoid redeeming investments linked to your financial goals

Financial goals refer to monetary expression of essential life goals. Some of the common examples of financial goals include corpus for a child's higher education/marriage, post-retirement life. 

Chaudhary said, "Liquidating your existing investments for crucial life goals might propel you to take up costly loans later on the maturity of such goals. Thus, prepay home loan only if you have adequate surpluses after factoring in your emergency funds, investments and monthly contributions set aside for your unavoidable financial goals."

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