Home Loan Prepayment: Pros and Cons

Owning a home is a dream for so many and you have taken the big step to achieve that dream, but at what cost?

High home loan interest rates, EMIs, and overall repayment at the end of 15-20 years is a burden that you carry for decades. However, by prepaying your home loan, you can be stress-free and enjoy lower EMIs. Let's dive deeper and understand how a prepayment will help you eradicate hefty EMIs and interest rates.

What is Home Loan Prepayment?
A Home Loan Prepayment is an option through which you can pay your home loan partially or in full. It helps you close the loan before the designated tenure. However, the banks charge a certain percentage of the loan amount if you close the loan early.

Advantages of Home Loan Prepayment

Save on Home Loan Interest Amount
One of the most prominent reasons people opt for a prepayment is to save on the interest amount which is a huge part of your total repayment. Let’s understand with a simple example:
You took a home loan of Rs. 50 lakhs for 20 years (240 months) at an interest rate of 8.65%.

Without Prepayment

• EMI = Rs. 43,852
• Total Interest Payable = Rs. 54.24 lakhs
• Total Amount Paid = Rs. 50L (principal) + Rs. 54.24L (interest) = Rs. 1.04 crore

With Prepayment

You decide to prepay Rs. 5 lakhs in the 5 th Year. You chose to keep the EMI the same, and the loan tenure is reduced.

New Outcome:
Your loan is paid 3.5 years earlier than the original tenure.

• Revised Total Interest Payable = ~Rs. 45.5 lakhs
• Interest Saved = Rs. 54.24L – Rs. 45.5L = Rs 8.74 lakhs

Peace of Mind with Lower EMI or Loan Tenure

With the above calculation, you see how much interest you will be saving if you prepay your loan. Now you have the flexibility to reduce your EMI or shorten your loan tenure and be stress-free.

Improved Monthly Cash Flow

With a reduced principal amount and EMI, you have more income available that you can use to fulfill other financial goals or investments.

Opportunity to Apply for Other Loans

The burden of one loan is reduced and this means you can apply for any other loan that was on your list. Home loan prepayment also improves your credit score and your chances of approval for other loans.

Faster Financial Freedom

Freedom is sweet and so is financial freedom. There is no joy sweeter than owning a home and going debt-free before time. As you save more on home loan interest rates, you can use that money in anything you want. It can be your next vacation, shopping, stocks or investment – the sky is the limit.

Better Credit Score

Prepaying your home loan is a great signal to the bank that you are a responsible borrower and boosts your creditworthiness.

Disadvantages of Home Loan Prepayment

Reduced Tax Benefits
Well, when you prepay a large amount of your home loan or fully prepay it, you miss
out on tax benefits. Here is how:

For example, you pay Rs. 1.8L as interest in a year and Rs. 1.2L as principal:

• You claim Rs. 1.8L under Section 24(b)
• You claim Rs. 1.2L under Section 80C

After prepaying a large amount of your loan:

• Next year, your interest component might drop to Rs. 40,000, and your principal to Rs. 20,000.

• You lose out on over Rs. 2 lakhs in potential tax deductions.

Prepayment Penalties

With prepayment, there are home loan fees associated with it. Usually, it ranges from 2 – 3% of the loan amount. Every time you opt for prepayment; you have to pay this amount. This is true for fixed interest rates but in case of floating interest rates, you don’t have to pay any prepayment charges.

Savings and Accumulation Required

You must be wondering why we discussed so much about extra charges and losing on tax benefits. But who will talk about the hard work and dedication it takes to accumulate a lump sum amount for prepayment?

Well, no matter how rosy it sounds, it is not easy to save money for prepayment and is a challenge. Individuals have several factors on priority and sometimes, a home loan goes down that list.

Opportunity Cost

Every expense has an opportunity cost but at the end of the day, it is subjective.When you prepay your home loan, you leave the opportunity where you could invest this money and earn better returns.

Liquidity Crunch

When you use your savings for a prepayment, you might not have a lot of liquid funds for your monthly expenses or any emergency. A proper prepayment strategy helps you keep liquid funds and opt for prepayment as well.

What to Know Before Opting for Home Loan Prepayment?

• Visit the bank’s website or physically to understand the prepayment terms and home loan fees in detail.
• After you know the prepayment terms, calculate a rough estimate of how much you will save on interest vs how much you will gain on investment returns.
• Choose the best time to prepay. Prepayment at a later stage of a home loan is not beneficial.
• Calculate how much liquid funds you will have after prepaying.

Conclusion

Home Loan prepayment is the best option if you have a lumpsum amount at your disposal. However, it is important to prepay during the early years of the loan. Opting for it in the later years doesn't matter because you have already paid a large interest amount. Analyze your options and choose the one that works the best for you.