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The key to making home loan prepayments

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Although reducing the tenure may ensure greater savings, slashing the EMI amount will help raise the overall proportion of disposable income

Although reducing the tenure may ensure greater savings, slashing the EMI amount will help raise the overall proportion of disposable income

Large loan amounts and long repayment tenures that extend up to 30 years make home loans one of the biggest financial commitments for any applicant. These factors also lead the interest cost on home loans to exceed the principal amount in most cases. Hence, many home loan borrowers tend to reduce their overall interest costs by making partial prepayments during the loan repayment tenure. Given that most lenders provide home loans at floating interest rates, existing borrowers are not charged any prepayment penalties if they make partial or full repayments on their home loans.

Home loan borrowers looking to reduce their debt burden by prepaying their existing home loan, either fully or partially, should keep the following points in mind before opting for home loan prepayments:

EMI or loan tenure

Existing home loan borrowers opting for prepayments are faced with two options — either minimise the EMI component of their loan or bring down their loan tenure. Although borrowers can make greater savings in their overall interest costs by reducing their loan tenure, reducing the EMI amount will increase the overall proportion of disposable income for borrowers.

Hence, the decision to select either option will primarily depend on whether the borrower wants to reduce the overall interest cost or reduce EMI burden with the aim of undertaking any future investments and expenditures.

Balance transfer

Home loan balance transfer (HLBT) facility allows existing borrowers to transfer their ongoing home loan to a different lender at lower interest rates and/or more favourable terms and conditions.

This facility is especially useful for borrowers with improved credit profiles who can take advantage of a declining interest rate regime to avail of home loans at reduced interest rates.

Exercising the HLBT option leads to reduction in overall interest payout for a borrower without negatively affecting either their liquidity or their ongoing investments.

Home loan borrowers should account for the estimated overall savings by using the balance transfer facility before they opt for shifting their existing loan to another lender.

Existing borrowers looking to transfer their home loan to other banks or housing finance companies (HFC) can also consider the home loan overdraft option — a home loan variant — if it is offered by the new lender. Under this variant, an overdraft account is opened, in the form of savings or current account and linked with the home loan account.

Home loan borrowers can deposit their surplus funds in this overdraft account, from which they can withdraw in part or full at a later date in case of future monetary requirements or fund shortages.

The balance amount left in the overdraft account is deducted from the outstanding home loan amount while calculating the interest component. Thus, the home loan overdraft facility offers dual benefits of loan prepayment and readily available liquidity for their borrowers.

Emergency fund

Emergency funds are created to tackle financial exigencies and/or for meeting unavoidable expenses such as ongoing EMIs, rent, insurance premiums and tuition fees for children during periods of loss of income caused by unemployment, illness or disability.

Emergency funds should ideally be large enough to meet any unavoidable expenses for at least 6 months.

Home loan borrowers who use their emergency funds or sell assets for making loan prepayments may have to redeem their existing investments at suboptimal prices to deal with adverse financial situations or avail future loans at much higher interest rates.

Several home loan borrowers tend to liquidate their existing investments earmarked for crucial financial goals to make home loan prepayments.

However, doing so can adversely impact their liquidity and long-term financial health apart from forcing them to avail costlier loans in the future just to fulfil those financial obligations.

Factor in returns

Although home loan interest rates are one of the lowest among retail loan products, they usually tend to be higher than returns generated by most fixed-income instruments.

Hence, if home loan borrowers had parked their surplus funds in fixed income products like fixed deposits, short-term debt funds that are not earmarked for any crucial financial goal, they can utilise them to prepay their existing home loans. However, the same strategy may not be applicable in case of equity investments.

As long-term returns generated from equity investments are usually much higher than interest rates of home loans, one should refrain from redeeming their equity funds for making home loan prepayments.

(The writer is Head of Home Loans, Paisabazaar)



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