A Deep Guide to Pre-payment of a Home Loan!

The sky-high housing prices have made it hard for ordinary persons to buy their dream home. Purchasing a house with your savings alone can be challenging. However, home loans can provide you with the required funds to finance the purchase. With the prevalence of online home loan websites, it is easier to apply for a loan online and get it approved in a short time. However, it is essential to check the loan repayment terms and conditions before taking a home loan. 

Two significant components are included in the outstanding balance; the principal amount and the interest charges. These two components also decide the EMIs you will be paying monthly for repayment. Prepaying the due balance is a great way to reduce the interest burden. 

Prepayment of home loans is a great way to reduce your debt and make room for a new line of credit if needed. However, there are some important factors to consider before you prepay the home loan. 

Understanding home loan prepayment 

Like any other loan, home loans too, have a maturity period. It can be between 5 to 30 years, depending on the requirements and eligibility of the borrower. Most people opt for high loan duration to reduce the monthly instalments associated with these loans. 

Home loan prepayment is the process of paying the outstanding loan amount before the maturity date. Since the borrowed home loan is usually high, the borrowers mostly indulge in part prepayments. Home loan prepayment helps to reduce the overall interest outgo on the loan for the borrowers. When people have surplus funds, they choose to prepay the outstanding balance in part or full. 

What are the charges associated with home loan prepayment? 

Prepayment charges on home loans can be explained as financial penalties imposed on the borrower for repaying the amount borrowed earlier than expected. I 

As per RBI guidelines, lending institutions don’t charge money for home loans offered on a floating interest rate. However, in the case of fixed interest rate home loans, or for borrowers who have chosen to use a personal loan instead of a home loan, or for borrowers who have taken the mortgage loan for business purposes, prepayment charges on the outstanding principal amount may be applicable, depending on the policy of the loan provider. 

Important considerations for home loan prepayment 

Here are some important considerations to be mindful of regarding home loan prepayment.

  1. Taxation 

There are different types of tax deductions that you can claim on account of home loan interest payments. As per Section 24B of the Indian Income Tax Act, one can claim a fair share of the interest payments as deductions. For self-occupied properties, the limit is up to INR 2,00,000 per year. So, if your prepayment does not lower the interest component for a year below INR 2,00,000, it won’t significantly impact the tax liability.

  1. The opportunity cost of prepayment 

Another essential thing to consider while making home loan prepayments is the opportunity cost associated with it. Think about the return you would get if you invested the same amount in a different financial product. If the return on investment from this amount is lower than the interest charges on the loan for that period, it is better to prepay the home loan. Let’s take an example to understand better. Suppose that you want to prepay the outstanding home loan balance of INR 10,00,000. Let’s assume the interest rate to be 10% and the rate of return for an alternative investment to be 8%. It makes more sense to prepay the home loan and save 2% in aggregate. 

  1. How are you planning to prepay the home loan?

It is an important question to answer before starting with the home loan prepayment process. How will you repay the loan amount? If you have surplus money to repay the outstanding balance, then it is good. However, if you plan to borrow from a different source or refinance the home loan, you must compare the interest rate and other charges that would add to the list of expenses. It is crucial to evaluate the feasibility of prepayment through different sources.

  1. Prepayment processing charges

Another important consideration that you must be mindful of is the prepayment processing charges. Some lenders may charge borrowers a fee when they prepay the loan amount. 

  1. Other factors 

There are multiple factors to be considered while doing a prepayment. It includes evaluating your income projections, financial backing, the purpose of investing in a home, etc. If you are expecting an increase in your income, prepayment is always a good idea to get rid of any existing debt.