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Is It A Good Idea To Pre-pay Your Home Loan?

Is It A Good Idea To Pre-pay Your Home Loan?

Is It A Good Idea To Pre-pay Your Home Loan?
You must complete the home loan tenure if the amount you save by pre-paying the interest is lower than the pre-payment penalty. (Dreamstime)

Anil Sharma, a 40-year-old-engineer who works with TATA Steel, plans to retire early. So, it made sense for him to pre-pay his home loan.

Do you plan to retire soon, too? No?

So, why are you in a hurry to pre-pay your home loan?

MakaanIQ tells you whether it is better to pre-pay your home loan, or to invest your surplus funds.  

Some home loan borrowers feel that debt is like a sword hanging at their neck. They fall back on their annual bonus, reserve money or savings to pre-pay their home loans and fulfil the obligation as soon as possible. This is not true of everybody. There are home loan borrowers who invest their annual bonus, reserve money or savings, allowing the loan to run its course. They do not consider their home loan a liability. It is reasonable to say that pre-payment of home loans have more to do with the personality and mindset of borrowers.

Now, let us understand what it means to pre-pay a home loan.

What does pre-payment mean?

Banks profit from the interest borrowers pay on their home loans. The equated monthly instalment of your home loan has two components: Principal and Interest. It is possible to pay the interest throughout your life, and still not fully repay the debt. As banks make profits out of your interest payments, they would want you to pay interest till eternity.

By estimating how much you would pay as interest at the end of 'n' number of years, you will be able to calculate how much you can potentially save by pre-paying your home loan.

Let us suppose Mr XYZ takes a home loan of Rs 1,00,000 at an interest rate of 10.50 per cent for 20 years. The total interest payable will be Rs 1,39,611, and the total payment on home loan (i.e. principal plus interest) will be Rs 2,39,611.

It is important to realise that repaying the principal amount of Rs 1,00,000 is easier. The interest payment of Rs 1,39,611 imposes a much greater cost on you. You must do everything you can to cut down such extra costs. This is where the “home loan pre-payment calculator” comes into the picture.

The home loan pre-payment calculator helps you save on interest payments. That is what pre-payment of home loans are all about.

What about the principal portion?

The principal portion is high during the initial years of loan tenure. This means that the interest charged will also be high. This is why, the loan balance declines over time. This is why low interest rates are paid on equated monthly installment's (EMI's) when the home loan tenure is nearing the end. By pre-paying the loan, we can pay-off the principal component faster, and contribute additional sums of money above EMIs.

Do banks charge for pre-payment of loans?

There is no such thing as a free lunch.

Banks charge for pre-payment of home loans, though laws on levying pre-payment charges have become more liberal. For instance, many lenders do not charge pre-payment fee for applicability of loan payment up to 25 per cent of the principal outstanding inclusive of all pre-payments made within preceding 12 months.

You must complete the home loan tenure if the amount you save by pre-paying the interest is lower than the pre-payment penalty.

Quick Tips

  • You must not pre-pay your home loan if you are enjoying substantial tax benefits under section 80C i.e. in terms of repayment of the principal portion of your home loan.
  • If you have extra cash, invest this in financial products that would give you a sure shot high yield at the end of a fixed period. Use the gains to pre-pay your home loan. The interest on what you gain must be higher than the interest on your repayment toward your home loan.
Last Updated: Thu Jul 07 2016

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