Should you prepay your home loan?

By BankBazaar.com | February 3, 2010

Saving on the net interest is the significant advantage of prepaying the home loan, other than the fact that you will retain the complete ownership of the house earlier than planned. The longer the loan tenure, the more the interest repaid, hence its best to repay your home loan in the shortest loan tenure possible, provided it can be managed comfortably within your income.

Everyone dreams of owning a home, which actually symbolizes a safe haven of security to retire to after a hard day’s work and a place where you can be yourself. This cozy nest is not actually yours just yet, legally speaking if you took a home loan for the property.

Are there times when you feel really impatient about this one nagging factor? That you need to wait several more years to free your home from debt? Also, with floating interest rates in a zig zag mode in the past few years, haven’t you thought about closing your loan soon before it becomes a lifetime repayment habit you cannot escape from?

Well, here is a thought for you. Have you considered prepaying your home loan? Here are some pointers in that direction.

First you need to check with your bank at what point in time during the loan tenure you can start prepaymentsfor your loan. Second, you need to find out whether you can make part-prepayments. Then you need to figure out what is the percentage of the outstanding loan amount you will be prepaying as prepayment penalty charge.

Most banks allow you to prepay up to a certain point without any penalty charge, so you need to ensure that your part-prepayments do not exceed this limit to avoid a prepayment penalty.

If you do pay a prepayment charge keep in mind – the prepayment charge should be considerably less compared to the interest saved.

You can consistently pay a part-prepayment, say every quarter, and conserve some of your savings for this purpose every month. This will bring down the principal you owe the bank, thereby reducing the outstanding loanamount and hence the net interest you will end up paying will consistently drop down.

Saving on the net interest is the significant advantage of prepaying the home loan, other than the fact that you will retain the complete ownership of the house earlier than planned. The longer the loan tenure, the more the interest repaid, hence its best to repay your home loan in the shortest loan tenure possible, provided it can be managed comfortably within your income.

Banks will usually cap your maximum EMI at about 50 per cent of your current monthly income. However you can make use of pay increases and bonuses to make part-prepayments on your loan.

Here is an example that illustrates how much interest you can actually save, when you opt to prepay your home loan.

Sharma took a home loan of Rs10 lakh (Rs 1 million) for a loan tenure of 20 years at a 12 per cent interest rate. At the end of his loan tenure, Sharma would have paid a net interest of Rs16.43 lakh (Rs 1.64 million). Instead he chose to use his annual bonus to pay two additional EMIs every year, and thus was able to wrap up his loan by the end of 13 yrs. Since his bank did not charge him a part-prepayment fee unless he paid off more than 25 per cent of the principal in a year, he did not have to pay any prepayment fees.

Your bank will provide you with the amortization table, based on which you can make your calculations on how much interest you will save.

The above table shows the results of the interest calculation based on prepayments made, which has enabled Sharma to close the loan 7 years earlier than planned. As a result he was able to save significantly, as the table above shows that by prepaying, he lowered the interest he paid on his home loan by 40 per cent.

Even if Sharma did have to pay a prepayment fee of four per cent, since the total amount of his prepayments is Rs 264,000, his prepayment fee adds up to only Rs 10,700.

Given that prepaying the home loan saved Sharma over 650,000, we see that the small prepayment fee does not alter the fact that Mr. Sharma made a very good decision by prepaying his loan.

In conclusion, if you can afford to make larger payments towards your home loan, perhaps because of a promotion or because of a bonus, then making prepayments towards your home loan is a very good idea as it will save you a lot of money over the term of the loan.

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26 thoughts on “Should you prepay your home loan?

  1. raja shekharan

    WHAT ABOUT THE TAX BEIFIT WHICH IS NOT AVAILABLE BY SHORT CLOSING LOAN… IS IT STILL WISE TO SHORT CLOSE?

    Reply
    1. shashank

      yes, it think if u foreclose the loan, u can opt for buying another property and start saving on your IT.

      Reply
  2. vasu

    Good point Raja. The article has completely ignored the tax advantage part. may be this was not written for Indian context.

    Reply
  3. Jaggia

    The article is v. much written for Indian context only as seen from the interest rate structure and the currency used theren. But there is yet another point needing clarification.
    It looks like the article takes into account only the floating interest rates. The author has not given any analysis or advice or prepayment on loan category of fixed rate structures. I recently took a 10 lakh housing loan on fixed interest basis. It is not clear if by foreclosure or making part-prepayments, to what extent and how will the I.T. benefits currently enjoyed be affected, and cost if any of the pre-payments. The points need further elucidation.

    Reply
  4. mukul

    When we talk about IT benefits we also need to understand that we get 1,50,000 out due to tax but then why not to pay 30,000 tax and take the remaining 1,20,000 back home instead of simply paying the interest.

    Reply
  5. Prashanth

    I have taken loan for tenure 20 years (240 EMI) instead opted for 8 years (96 EMI) where my EMI became more. is this worth than making prepayment every quarter.
    for first 5 years if i pay i get tax exemption for 150000 plus my principal amount also right.

    Reply
  6. srinagesh

    I hv a 15yr home loan at 7.5% Fixed Interest rate – abt 7 lacs outstanding + a top up loan of 1.8 L at 8.5% Fixed Interest rate – abt 1.6 L. The loans are 5 yrs old now.
    What is your suggestion, as i can afford to close the loans even on a single go. I think that the 8.5% loan shld be closed whereas 7.5% loan shld continue. Pls advise

    Reply
  7. Raja

    Valid point Mukul. Instead of paying as interest to the Bank, pay it as principal towards the housing loan.

    Small correction on Mukul's point. If the tax slab is 30%, one will end up paying 45,000 as tax, but still can use remaining 1,05,000 to pay back the principal for home loan and close the loan as early as possible.

    Reply
  8. Arup

    Hi All,

    I have done a small calculation on the tax advantage of home loans.
    The max advantage for self occupied house is Rs 150000. The max advantage in terms of income tax is @ 30%. This comes to Rs 50000.

    Now if we compare the annual outgo for a 20 yr / 19 yr loan it is seen that every yr we delay closing the loan we end up paying around Rs 1 lakh more.

    In this perspective it is better to part-prepay the loan. Also remember that part prepayment of loan in the initial 5 years starting from the 1st yr is more beneficial as the effect is seen more in terms of reduced no of EMI's that is required to be paid.

    Reply
  9. Home Loan Rates

    It sounds like you're creating problems yourself by trying to solve this issue instead of looking at why their is a problem in the first place

    Reply
  10. Prepaymeny question

    Hi,

    I had taken a housing loan of 6 lacs for a flat which is in name with my mother being the co-owner and co applicant of loan. The loan was taken 2 years back and since then I am paying the monthly EMIs (principal + interest)and also claiming the tax deductions for the same.
    I have paid the EMIs from March 2009 to Dec 2009 . In January 2010 ,my father prepaid the entire loan amount of 5 lacs .
    Now , for my tax proof submission , the document proof that I get from the LIC HFL states the Principal = 5 lacs and interest =40,000 for the financial year 2009-2010.

    Can I show this document for my tax proofs submission since it says principal = 5 lac and the EMI amount which I paid from my salary was only till Dec (approx 72000).

    What document should I submit as proof for my tax deduction ?
    Kindly help.

    Reply
  11. Sujith

    What about the opportunity cost in prepaying?if we invest the prepayment amount in some high return investment opportunities like mutual funds/stockmarket/real estate we can earn more returns than the interest cost saved by prepayment.

    Reply
    1. Ranbir

      This is a risky proposition. If your mutual funds do not yield the promised rate of return , you will face a double whammy. Added to the pressures of your EMIs, you will now find that your valuable savings have been locked up in some poor performing funds. The right thing to do, as the author suggests is to try and close the loan at the earliest .

      Reply
  12. Shailesh

    Is there any way to find the benift of loan prepayment considering the IT exemption part (principle + interest) taken into consideration?

    Reply
  13. noone

    Give thanks to you for such a helpful webpage. Where else could one get this sort of advice published in such a fantastic way? I have a business presentation that I am at the moment working on, and I have been on the look out for such info.

    Reply
  14. NoOne

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    Reply
  15. Cherian Mathew

    Hi,

    I had taken a housing loan in year 2009, emi of Rs. 14717 started from June 2009. I had paid so far 25 emis on the housing loan. Now I am about to get a bulk amount close to Rs. 1 lacs. from my organisation. Is it a wise decision to invest that money towards housing loan as bulk payment to get interest benefit or Invest that money to take gold coins ?? Please advice.

    Thanks in advance.

    Reply
  16. vasan

    we have taken a home loan of 8.65 lacs for 9 years at 9.5%. Now we have 7 lacs outstanding with balance 78 emi. Our friend has offered to loan 5.5 lacs at 5.5%. interest. Is it benefecial to avail the opportunity and pre-close the home loan also taking into account the tax benefit we get now.

    Reply
  17. Praveen

    Can we close Home Loans before 5 years?I heard the income tax benefit will cease.. Is this allowed. Please clarify?

    Reply
  18. Suny

    I have 2 loans . Details 1) Loan is for Rs. 10.70 lacs outstanding , this loan was taken fr Rs. 15 lacs , now I am into 7 years of loan, Second loan I had taken for 34 lacs in the month for 2 n. d house . I am enjoinging tax benefits for both the house , also I have been part paying my both the loans small amounts simultaneoulsy

    One question I have , should I close my first loan whose amount is relatively less ….pls suggest.

    Reply
  19. krishnan

    i have housing loan in a nationalised bank.i am paying rs 17 000per month as emi.iwant topay rs 5 lakhs now and reduce emi to rs 13000 per month.can i do this

    Reply
  20. dinesh

    if we paid more then 1.5 lacs house prepayment principal then there would be any problem in income tax file or not kindly clarify

    Reply
    1. Team BankBazaar

      Dear Dinesh,
      Thanks for writing to us. The income tax exemption for principal repayment is fixed at Rs.1.5 lakh by the Government of India. You can claim an exemption up to this amount every year on your Home Loan. With respect to the principal amount of your loan, you can repay as much as you want without it affecting your tax exemption. There are no restrictions on this and it has no relation to your income tax filing.

      Cheers,
      Team BankBazaar

      Reply
      1. dinesh

        means if i having the loan of rs 500000 i can pay it in one transaction also means in single financial year without any tax

        Reply
        1. Team BankBazaar

          Dear Dinesh,
          Yes, you can prepay your Home Loan without any impact on your taxes.

          Cheers,
          Team BankBazaar

          Reply

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