Usually the question raises in minds of many home- loan borrowers after accumulating some cash that whether to prepay home loan or to deploy the surplus funds in some other investment products. The answer of the question depends on various factors and it cannot be a readymade. Let us discuss the criteria which you should evaluate while taking such decision.
Future needs of money in future
- Before taking the decision to prepay your home loan, it is necessary that you make an assessment of money required in near future to meet various needs like education needs of your children, etc. As home loan is the cheapest form of borrowing and in case you need to go for any loan, to meet your future requirement, the cost of such borrowing will be at hugely higher say around 12%-15% for personal loan or gold loan as against 7% annual rate of interest which you pay presently for your home loan.
- The present pandemic situation also has its huge impact on assessment of your future needs. Since the time frame within which we will be able to come out of Covid-19 pandemic is not easy to predict and you are not sure whether you will be able to retain your job or not. So in this case I suggest you to make a contingency fund to cover expenses for 12 months instead of 6 months which is generally recommended in normal times.
Tax benefits available for home loan
- Though no one buys a house just for the purpose of save taxes but it is a fact that your home loan certainly helps you to save taxes and you should certainly evaluate the impact of making part or full prepayment on your overall tax liability.
Charges payable to the lender for prepayment
- The lenders may charge you certain fee in case you wish to prepay your home loan either partly or fully before its original tenure. Whether the lender will charge you for such prepayment or not will depend on whether you have taken the home loan from a bank or from a housing finance company and whether the home loan is under fixed rate or floating rate.
- For instance, the housing finance companies are not allowed to collect any prepayment penalty if the borrower is closing the home loan without taking another loan. However, the bank may still charge you for prepayment. Some banks allow you to prepay up to certain percentage of your home loan outstanding at the beginning of the year without attracting prepayment penalty. So evaluate the cost of prepayment charges while taking the final decision.
Alternative Investment Avenue
- The simple rule- If you think you will not be able to generate better post tax returns than what you are presently paying for home loan, prepay the home loan immediately. Since the home loan is a product of long tenure extending up to 20-30 years, one has to evaluate returns of other alternatives for equally long period.
- The comparison should not be made with returns offered by products like fixed deposits, etc. If one goes by the historical returns of equity for past 40 years, the Sensex has generated returns of around 15% on annualised basis. So those of you who have risk appetite and also the ability to take risk- in case you are below 40- you can start investing in reputed equity mutual funds schemes for the balance tenure of your home loan.
Family pressure and psychological reasons
- Sometimes your family members may pressurise you to foreclose your home loan as soon as it is possible, especially those who are from old school of thoughts, who do not wish to have any loan on their head for the house.
- They want their house to be debt free. Trust me this single reason constitutes significant proportion of the cases in India where the home loan is fully closed before its original tenure.