Like most homebuyers, you may also have availed of a loan to purchase your own property. A housing loan is a long-term commitment and often requires spending a major chunk of your monthly income in repaying the borrowed amount. You may want to repay the loan earlier than the specified loan tenure to procure freedom from this financial commitment. In the past, financial institutions levied a prepayment penalty if you wanted to prepay the loan amount. However, new guidelines from the Reserve Bank of India (RBI) forbid lenders to levy such penalties. A home loan is an excellent way to realize your home ownership dream. Additionally, such loans offer tax benefits as per the Income Tax Act, 1961. You may contemplate whether prepaying the loan amount or taking advantage of these tax benefits is a more lucrative option. However, if you want to repay the borrowed amount earlier, you need to make a prudent financial plan. Here are three tips that will help you repay the home loan earlier.
1. Increasing the monthly installment
Most financial institutions limit the Equated Monthly Installments (EMIs) on home loans to between 40% and 50% of your take-home income at the time of approval. However, as your income increases, this ratio decreases because the EMI remains constant while your earnings are higher. If you want to repay the borrowed amount before the due date, it is recommended you retain this EMI to income ratio. You must increase the EMI with the increase in your income to repay the loan faster. Maintaining financial discipline will help you repay the loan amount earlier than its entire duration.
2. Smart utilization of additional income
It is common for most employers to pay an annual bonus to employees. Instead of spending this money on a vacation or other desires, it is recommended you partially prepay the outstanding loan amount. This will not only help you to reduce the actual tenure of the home loan repayment but is beneficial in decreasing the total interest paid on the borrowed amount. Another common dilemma that you may face when you receive any additional income like the annual bonus is whether to invest or to make a partial prepayment towards the housing loan. Most financial experts recommend that investing such monies depend on the expected rate of returns. In other terms, if the investment is expected to deliver returns that exceed the rate of interest on your home loan, investing it is a financially more prudent decision. However, if the housing loan interest rate is more than the potential return on investment, making a partial payment to reduce your financial burden is advisable.
3. The appropriate time to prepay
During the initial years, once you avail of a housing loan, a larger component of the EMI comprises the interest payment and only a small portion of the EMI is utilized towards the principal repayment. However, as the loan tenure draws closer to its end, a higher component of the EMI is used towards the principal repayment. Therefore, if you want to prepay the housing loan, it is advisable to do so during the initial period. This will help reduce the total interest you pay on the borrowed amount. However, it is important you do a detailed cost-benefit analysis to determine the exact savings you will enjoy if you prepay the loan during the initial years. Savings does not simply mean investing and earning returns on such investments. Reducing the interest costs is also a potential saving especially over the long-term. Although repaying the housing loan earlier is beneficial, you need to always retain a contingency fund to meet any unexpected situations like a medical emergency or loss of your job. It is recommended you retain at least six months of your monthly expenses and three months EMI to ensure that there are no financial difficulties. Related Articles: