One fine day, when you decide to make a list of all the debt avenues you have accessed, it might be a little shaking as you finally would realize the prepayment burden on your pocket. But how do you decide, which loan you need to prepay first? Well here are some guidelines:
Try to prepay your credit card loan first, since it is believed to be the costliest, as it carries an interest rate of 45% .
If you have a car loan or a personal loan, pay off the one that has more interest rate on it. If you keep paying only the minimum amount due and keep rolling the credit, it would take you around 5 years to pay off a balance of just Rs.5000.
Loans without tax benefits:
The current rates of interest on a personal loan are touching 28% per annum, but there times in the interest cycle when these dip to about 13%. If you are sitting on a car loan of 15% at that point of time, it would make sense to pay off the car loan first and then tackle the personal loan. But remember the car loan may come with a prepayment penalty, usually 2% or as high as 5%. So, it doesn’t really make sense to pay off the car loan first.
Loans that offer tax benefit:
Once the costlier loans have been taken care of, look int those loans that offer a tax benefit. The tax benefit option makes the effective interest rate lower.
Education Loan:
These loans are generally not expensive compared to a personal loan or a car loan. As per the Section 80E of the Income Tax Act, you are benefited from the tax deduction on the interest component.
Home loan:
You are entitled for tax benefits on both the interest as well as the principle component of your home loan. Under the section 80C of the Income Tax Act, the principle repayment of up to Rs. 1 Lakh can be used as deduction. Under Section 24 of the Act, you can get a deduction of Rs1.5 Lakh for interest payment. If you hold the house jointly with your spouse, both of you can get tax benefits for the principles as well as the interest amount. If you plan to rent the house, the entire interest amount you pay is tax deductible.
Prepaying any loan is always a good idea to reduce in your financial life. If in case you are unable to prepay the entire loan amount in one shot, it is advised if you could prepay at least a part of it.