Neeraj, a middle class sales and marketing professional based in Pune, purchased a decent abode in a metropolitan by securing a home loan worth Rs. 24 Lakhs from a leading financier. Divided into easy monthly installments, Neeraj was reducing his liability quite comfortably. Being able to increase his bank balance to Rs.8 Lakh, Neeraj found himself in a dilemma of whether to invest his hard-earned money for the future or prepay a major chunk of his home loan. Living under the notion of heavy prepayment penalties, Neeraj let his instincts prevail and opted to channelize his surplus funds towards an unhealthy investment and ended up on the losing side. Had he been aware of the changed prepayment rules and acted smartly, he would have successfully used his surplus funds to reduce his burden.
There is an interesting irony when it comes to home loans. Till the time people don’t have such a liability, they yearn to get one at the earliest possible and fulfill their dream. However, once they apply for home loan and secure the required funds, repaying it in a timely manner becomes the top listed priority in life, even if that means compromising with their standard of living. With the prepayment option now in the picture, the repayment process seems even more challenging than before. Prepaying a part of the home loan is certainly a prudent decision. The final decision will definitely rest with the borrower, who must take into account the associated benefits and the hidden costs, before jumping the prepayment bandwagon. Do remember prepayment charges according to the RBI mandate are applicable only on fixed rate home loans in most banks.
Why is Prepayment a Good Option?
One of the primary benefits associated with loan prepayment is the significant reduction in the interest outgo. When one prepays a certain portion of the mortgage loan, the outstanding balance from the principal amount is reduced, which consequently helps in cutting down the interest payout. Indirectly, this helps in bringing down the original value of the home by a substantial amount. If selling the property is on the cards in the future, one can easily and quickly recover the original cost and make profits from a bigger property purchase.
What are the available options?
When people consider the option of prepaying a debt, they have two options at their disposal. The bank allows them to either reduce the amount of their monthly EMI and maintain the tenure, or have the tenure reduced by lowering the number of monthly installments. Retaining the tenure and reducing the amount of monthly EMI certainly help in improving the cash flow. While, on the other hand, reducing the loan period and maintaining the same EMI would equip them with the power to enjoy interest savings over a period of time. One just needs to assess the options according to personal convenience and make an informed decision.
How much will it cost you?
The financiers make their money in the form of interest, service charges and other kinds of fees charged on loans and advances given to the customers. It goes without saying that banks will make profit only if the loan accounts remain open for a great deal of time. The banks can’t sojourn the right of the borrowers to prepay their loans. However, at the same time, it would certainly mean upsetting the overall profits of the bank. This is the reason why banks levy penalties on the borrowers for compensating their lost profits. The penalty fee charged on prepayment varies from one bank to the other.
Here is a tally of prepayment penalties charged by some of the top home loan providers in the market.
|ICICI Bank(Zero charges on floating rate loans)||
|State Bank of India||0% prepayment penalty irrespective of the period of account or source of funds.|
|Punjab National Bank||2%, only in case the account is taken over by other bank or financial institution.|
As on April 6, 2014
The Final Call
Though the home loans come with long repayment periods, it doesn’t mean that they have to be dragged for decades. If one is sitting on a strong pile of money, channeling it towards well-calculated prepayments would be a wise move. At the end of the day, it is the dismissal of unnecessary EMI burden that helps in maintaining a healthy cash flow over the period of time.
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YOU MAY ALSO WANT TO: Find out how your EMI is doing – Home Loan EMI Calculator