It is a common practice to take a Home Loan on flexible rates of interest rather than a fixed one. The reason behind this universal exercise is the fact that rates decrease and the person taking the loan stands a chance to benefit from this change in rates. However, this move may not always have a favourable outcome.
The Reserve Bank of India has slashed interest rates by approximately 150 points. However, banks have been slow in passing on the rate cuts to exisitng borrowers. The rates of interest on Home Loans after progressing on to the Marginal Cost of Lending Rate (MCLR) currently range between 8.5 and 9.5 per cent. Now the real question arises – if your Home Loan EMI still remains the same, how does a pre-MCLR borrower avoid losing money when you don’t want a balance transfer?
One quick solution to this dilemma is that alongside paying the mandatory equated monthly instalment (EMI) regularly, the borrower can tap into the possibility of making advance payments towards the repayment of the loan. This will ensure that the loan is paid fast and savings can be incurred by banking the money which would otherwise drain their finances in the form of accumulated rates of interest. This form of repayment can be carried out through partial fee, which is a kind of prepayment. This is the amount invested towards clearing the loan in addition to the fixed amount of EMIs dedicated towards the same purpose. As a result, the primary loan amount will get reduced and the rate of interest will be applicable on the reduced sum.
You can look at it this way – Just like a Systematic Investment Plan (SIP) is functional in the domain of Mutual Funds, similarly Systematic Partial Prepayment (SPP) plan can be effectively put into action for Home Loans. SIP assists in promoting financial stability, and SPP helps in saving the outgo of cash from your reserve. It is a smart and effective solution to a complex problem.
Bonus Reading: MCLR Linked Loans – More Affordable Loans For You
Benefits Of Implementing Systematic Partial Prepayment (SPP)
If you have taken a Home Loan, then interest rates will continue to drain your personal finances in the process of reclaiming the principal amount lent. With the system of prepayment however, you will be able to cut the cost and save money by decreasing the time period required to pay back the loan in full. The faster you get rid of the debt of the main amount, the lesser interest you will have to bear. For instance, if a Home Loan of X is taken at the rate of interest Y and the borrower takes 10 years to repay the amount in full then alongside paying the amount X, he/she is also paying Y of X additionally. In short, the longer you take to do away with the loan, the more interest you will incur on the principal amount.
Bonus Read: Should you prepay your home loan?
Gathering The Investment For Prepayment Activity
It is a general practice to forward loans in a way that the EMIs do not go beyond 45-55 per cent of the borrower’s salary. More often than not, people also have other EMIs to pay, such as repayment of Car Loans etc. The best procedure to follow is to make a list of all the expenditure and then take out an amount which can be directed towards the repayment scheme. In case it is not feasible to keep aside the money due to overhead fixed cash outflow, a person can work in association with his/her partner (who is an earning member) and contribute towards the early payment option. Amount received as a bonus, gift, or windfall can additionally be included in the fund kept aside under SPP.
Why Is Prepayment Beneficial?
You can view it this way – by making regular prepayments, you are in effect lowering the final price of your home. The amount that you are paying towards the interest rate on the principal sum becomes a part of the money you have ultimately invested towards your property. For instance, if you have taken a Home Loan of amount A at the interest rate of amount B for a period of time, then after your property is established, the cost of it would be A + B.
It is wise to keep the cost incurred as low as you can and the technique of prepayment may prove essential in achieving that goal.
Bonus Read: The Dos And Don’ts For Home Loan Prepayment
The Choice between Prepayment and Investment
It is a difficult choice between directing your reserved funds either towards prepayment of the Home Loan or investing them someplace else. It is a problematic situation and making a decision involves a lot of thought. One answer to this question can be – if you are able to produce returns greater than the amount you are paying off towards your loan. We can look at the interest rate after you have successfully reclaimed your tax benefits off of it.
For instance, on the primary amount, you incur a rate of interest which amounts to Rs. C while only Rs. B is liable to taxation. Depending upon the percentage of your slab, the amount payable as interest will differ yearly. Since the said amount is not scrutinised for the purpose of taxation, your real rate of interest will decrease a good amount. It will continue to subside with each passing year. Here, you can decide if you want to invest your money or use it towards prepayment. In case your new interest rate, which is calculated based upon the above stipulations, is lower, then you can go with the clearing of Home Loan instead of putting it somewhere else.
Bonus Read: How To Plan Home Loan Prepayment
The Option of Overdraft Home Loan Accounts
Some financial institutions offer the facility to keep an overdraft Home Loan account towards the repayment of the debt. They are general savings accounts in which you can keep funds which are ultimately regarded as a portion towards partial repayment. No scheme comes without strings attached, however.
This system has two downsides – The rate of interest towards the Home Loan can be slightly more than a non-overdraft option scheme, possibly by 0.25 per cent. The second deficiency is the fact that there is no Section 24 benefit.
The Easy Mode of Prepayment
Prepayment can be handled according to your financial stability and plans. Normally, the lending banks accept a prepayment of an amount equivalent to the amount of a monthly EMI. You can form an action plan and decide how often you would like to make a prepayment. You can go ahead and do it every 6 months or even quarterly. The fact that there are no stringent dates and time involved with prepayment makes it an easy and flexible practice. You can make the investment whenever you are comfortable with it. However, it is wise to contact the bank and talk to them about repayment policies that they may personally be following.
Clauses Associated With Prepayment
According to the rules and regulations of the Reserve Bank of India (RBI), a bank cannot levy any penalties or charges on prepayments on individual money borrowers. The loans with a flexible rate of interest cannot be subjected to such a practice and therefore, it becomes essential for the bank to ensure that the prepayment is made from the borrower’s own personal finances. In order to meet this condition, the bank makes it mandatory to furnish the account statement of the person to whom the money was lent to.
Prior to Prepayment
Making a prepayment towards ensuring cost cutting of interest rates is a good decision. However, it is equally important to be aware of your finances before proceeding with the action. The first step towards maintaining financial health is keeping sufficient emergency funds at your disposal. Unforeseen events and expenditures can strike at any given moment and financial security is of utmost importance to be able to deal with them. Secondly, keep the funds for future expenses aside. For instance, retirement funds, education money etc. It is important to not spend all your savings in an attempt to prepay the loan. Be wise and make a well-informed decision before starting the program.
Everything needs a well thought-out plan for perfect implementation. Goal-oriented decisions help people succeed in their endeavours instead of impulsive actions. Prepayment as an option is viable for people who have stable earning with a good bank balance at their disposal. It is not wise to spend all your future savings towards this, but instead to draw out an effective course of action before considering the prepayment method. Prepayment helps you get rid of your loan as early as possible. With the correct planning, it can benefit an individual immensely by saving them a great amount of money.