Home Loan – should you disperse or keep paying it?
A home for our self is a precious feeling, an incomparable materialistic achievement and a commendable feat of a lifetime. Everyone treasures the first home they ever bought. For most of us, home loans are a preferred way to achieve our goals.
You come into an unexpected lump of money – it’s a Diwali bonus, or the huge amount that you had lent to your relative has been returned before the time they had committed to return, your parents had put a secret Fixed Deposit under your name which is up for withdrawal, or just a raise for all the hard work you have been putting on the work front has finally paid off! Now, what do you do with this amount of money? You crave to take that foreign family vacation that has been your dream for way too long, and on second thought you consider closing your home loan and before long, you have a list of ways you can use the money and all the pointers seem important at the same time but the money is not enough to be distributed equally among all desires. But if you do decide that home loan is a priority and needs to be closed immediately, here are a few advantages and drawbacks that are associated with the prepayment of home loans.
- Reduction of interest payouts – The discernible advantage of prepayment of a home loan is that the interest payout reduces. When you prepay a considerable amount of money, the amount gets deducted from the principal amount and hence the amount on which the interest is charged is comparatively low resulting in a lower monthly interest payout (EMI).
? Do not reduce the tenure of the loan – If you reduce the tenure, your home loan will disperse a few months early, but you still will pay the same amount every month. For the common man, it is best to keep the installments same but reduce the monthly EMI payments. The extra money can be invested in profitable investment programs and used later to prepay the loan if needed.
- Balance is the key – Debt Equity Ratio is the classic financial ratio which allows analysts to determine how risky a financial decision is. The higher loan you have in terms of %, the higher is the risk for banks and lenders to finance your loan. If the real estate markets tank by a certain percentage which reduces your stake on the loan to null, you home loan is a higher risk to the lenders and in order to keep their profits in check, banks and lenders will charge a higher rate of interest on your loan. The ideal debt equity ratio is 7:3 to 8:2 which means that the Loan to Value of your property is 70-80%. Higher than this, your leverage ratio will adversely affect you. So you should try to attain the ideal debt equity ratio.
- Tax benefits – Under Section 24, a maximum of Rs. 2 lakh is allowed as the deduction for the interest component of the EMI paid during the financial year. Even for an individual coming under the highest tax bracket, this Section grants the provision of reduction of taxes of around Rs. 60,000 in a year. First- time buyers have an additional advantage of deduction of up to Rs. 50,000 under Section 80EE, towards the interest component, over and above the deduction of Rs. 2 lakhs. On the principal component of the EMI, Section 80C offers benefits of up to Rs. 1.5 lakhs.
So, after a balanced evaluation, keeping all factors in mind, it is best in most cases to not prepay a home loan aggressively. It is poignant to invest smartly and find attractive investment opportunities either in debt or equity and earn a superior return compared to the tax adjusted interest rate paid on the home loan. Draining your entire savings account to prepay a home loan and left with no fund to be used in cases of emergency is something you would like to avoid.