Home loan prepayment – When and why?

Home loan is a long term commitment often spanning over 2 decades and involves substantial amount money which the borrower takes and even more which he pays back in the long term. There are certain conditions under which the borrowers may want to prepay the home loan before end of the agreed term. There are different implications to such a move and the decision must be taken only after carefully analyzing all the implications.

Basic Consideration

If at all you have some spare cash available to prepay some outstanding loans it is preferable to liquidate the personal loans and car loans before thinking of prepaying a low interest home loan. The home loan as such continues to earn tax exemptions and hence should be the last priority in prepaying. Such a move should only be considered when there are adequate reserve available after all essential investments and retirement planning has been looked after.

When to Prepay a Home Loan?

Increase in the interest rate is one situation where one can consider a full or part prepayment of the home loan so as to save on repaying excess amount of interest by the end of full tenure. However in such a case one must be prepared to pay some amount as prepayment penalty. The Reserve bank of India in its latest guidelines has advised the banks against charging prepayment penalties on home loans which can be taken advantage of in the current scenario.

Repay early or later in the Tenure

While prepaying a home loan in the first 10 years one must bear in mind that this the phase when the borrower is likely to be young and get a huge rebate on the interest up to Rs. 150000 and on principal up to Rs. 100000. At a later stage after 10 years there is still some amount of interest being paid as well as a major portion as principal which is being and it can be used to avail tax benefits. Additionally since one has paid the major portion of interest for the entire period initially it is not advisable to liquidate the loan whose interest is already paid for. However if one has only a few years of earning left then prepayment will be a wiser decision should the opportunity present itself.

Why to Repay?

The foremost reason why one should think or prepaying a home loan is to save on the overall interest by repaying some amount of the principal in advance so that the base value of the loan reduces.

Prepayment of home loan also counts towards tax rebate under Section 80C as it is being used towards prepayment of the principal.

The borrower also must take into account the other investment options that are available to calculate whether using the cash in hand to prepay the loan will more or investing it some decent instrument will earn more in the long run taking into account the savings in terms of tax exemptions during that period.

Additionally the prepayment should be made whenever there are sufficient funds to meet unforeseen situations and emergencies. Wiping out all emergency funds to prepay a home loan may not be a good idea.