Pre-paying a Home Loan – Good Idea or Bad

HOUSING | Tips & Advice 24 November 2021

Introduction

Pre-paying a housing loan is also known as pre closure or prepaid loan. It essentially means the early payment of the remaining loan amount before the date / tenure which was agreed upon during the loan contract signing. People may prepay loans either in part or in full. This is usually as a result of an unexpected windfall or reaching higher levels of earning, which gets the borrower to the situation of being able to clear off the housing loan before the agreed tenor. But while making this decision, it is worth deliberating certain other aspects or alternative viewpoints to be clear in thoughts and action.

Pre-paying a Home Loan – Good Idea or Bad

Factors To Be Considered Before Pre-paying a Loan

  • Prepayment or Pre Closure of the loan can lead to big savings due to the interest related expenses which would have been incurred. In case the housing loan is prepaid in early stages, these savings will easily outweigh any other considerations. Hence, loan preclosure in an early stage of the loan period is highly recommended. It is worth checking with your lender if there is any lock-in period involved in the loan contract. This would entail that the loan cannot be prepaid until that lock-in period is completed.
  • Prepayment Charges are an important aspect which need to be considered as well. Banks and non-banking financial companies (NBFC) tend to charge a certain amount which may be 1.5%-3.5% of the loan amount. One may question why a penalty is being charged for earlier repayment of the loan, as the lender is getting their money back before time. Well, the answer is rather simple. The lending institutions make their projections and future investment plan based on the anticipated income through the interest amounts. With early closure of the housing loan, they regain the principal but lose out on the remaining interest, which means making some revisions to their business plans. You need to carefully calculate the amount you expect to save by early payment versus the prepayment charges and decide what seems beneficial to you. It is worth noting that as per the RBI mandate, prepayment charges are no longer applicable on loans with floating interest rates.

In Summation

Ideally, early repayment of loan whether in part or in full is a beneficial idea since it helps to save huge costs in the form of interest to be paid to the lender. It is extremely beneficial if done in the early stages of the loan tenure to provide the maximum savings.

However, if you are at a late stage in the duration of your loan period, this decision is debatable. In such a scenario, you will need to consider the prepayment charges of your lender and then do the calculation whether the savings from interest outweigh the penalty charges or the other way round.

Another aspect that may be considered is whether the amount you intend to give the lender for early repayment of the housing loan may be better invested in some financial tool. The returns on such an investment (like in equity-backed tools) may be far more superior to your anticipated savings. Having said that, do note that market returns can never be guaranteed to the frequent volatility of its nature.

Home loan also offers tax benefits in terms of deduction from the annual taxable income. These benefits will cease to exist after the loan repayment. This is also worth considering in your overall calculations, as it is easy to miss this point.

So, it is recommended not to take any decision in haste. Read the loan terms and conditions carefully and invest some time in calculating, in detail, the projected savings versus the money being spent, including the prepayment charges and other penalties.

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