You Needn’t Rush In Prepaying Your Home Loan!

By | May 10, 2012

From a healthy financial investment point of view, it is important to get of rid debt as soon as possible, however, it is even more important to evaluate the cost and benefit involved in making such a decision. The first step is to know what kind of loan you have opted for. Is it a personal loan, home loan, car loan etc and then evaluate the interest and tax mechanisms. The effective rate of interest which is applicable net of tax benefits is your real cost of loan and not only the interest which you pay on the same.

If it is a personal loan or a credit card loan it is better that you repay them back since these loans do not provide any tax benefit and moreover carry exorbitant rates of interest. But if the loan in question is a home loan then it is important to understand as to how the borrower utilized this loan. There are three scenarios that fall under the evaluation category.

Scenario 1:

If you are a home loan borrower and have borrowed for the purpose of purchase or construction of your house, you are entitled for a deduction as stated by the Income Tax Act.  Subjected to a few conditions you are granted deductions up to a maximum limit of Rs1.50 lakh. But the downside to this is that you will have to pay more in terms of the interest outflow. This means that the overall real cost of the loan does not lower down considerably. If you are in such a situation where the interest component is higher, it is better to pre pay the loan as much as you can so that your EMIs will be lowered.

Scenario 2:

If you are a holder of a leased property, the tax deduction on your loan is available on the completed interest amount. This means that the total real cost of the loan comes down considerably and can provide you deduction of up to 30%. Also, the benefit also depends on the marginal rate of tax. If this is the case, it is advisable for you to continue the loan and pay your EMIs regularly, but, you need to be watchful about the interest rate. If your return on investments is higher than the rate of interest, it is better to continue else, pay off the loan.

Scenario 3:

If you are purchasing a property that is under construction, things can get a little complicated. There are two approaches to this scenario, first; if the real cost of loan is greater than your Return on Investment (ROI) it is better to prepay the loan as this will reduce your EMI payments once the complete loan is disbursed. Secondly; in situations where the real estate may be going through a turbulent phase, you may be required to pay the cost of the property immediately in order to avoid delays in the completion of the project.

Considering all these above mentioned scenarios, it is important that you understand where you stand in terms of investments. If you have managed to build a good corpus, it is advisable to pay off the loan depending as to which scenario you as a borrower come under. Also, buying a home loan insurance cover can prove to be quite helpful if in case any unforeseen circumstance like a job loss or a critical illness engulfs you wherein you might not be able to receive a monthly income. The cover can be worth the home loan amount so that your dependents will own the home and not the necessarily the debt that comes along with it.

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