When you buy a house on a home loan, you take into account your current income and accordingly get the home loan sanctioned based on the eligibility. Gradually borrowers are able to accumulate surplus fund with increase in salary or increased other sources of revenues. Such borrowers face a dilemma of whether to prepay the home loan or should invest in some other products. The answer is very tricky and can't be the same for everyone. Let us discuss all the factors that affect your decision to prepay your home loan.
Funds requirement in future
You should prepay the home loan only after taking into account the requirement of funds in near
future including for contingencies. Your decision whether to prepay and how much to prepay should be based on these consideration because the home loans are available at relatively cheaper interest rates than other loans like personal loans and gold loans. In case you need money in future after having prepaid the home loan, you may have to borrow at far higher rate of interest as gold loan or personal loan. So, ensure that you have adequate contingency funds before you opt to prepay your home loan partially or fully.
This decision is also dependent on impact of such repayment on your eligibility to claim interest
deduction under Section 24(b). In case, the property is self-occupied, you are allowed deduction only up to Rs2 lakhs of interest per year for interest. So, as long as any part prepayment doesn't bring down the amount of interest below Rs2lakhs, it will not have any impact on your tax liability.
However, if the property is let out, the decision would be different as entire interest payment is fully tax deductible but the total loss under the head 'income from house property,' which can be set off against other income is restricted to Rs2 lakhs for all the properties taken together. The unabsorbed loss (which arises due to interest on home loan) can, however, be carried forward for set off against income from house property for eight subsequent years.
Processing charges for prepayment of home loans:
The lenders generally charge some prepayment charges if you prepay any home loan. The quantum of such charges is dependent on the terms agreed at the time of taking home loan and is per the agreement executed by you. Such charges vary between 0% and 4%. As per a circular issued by the National Housing Bank (NHB), the housing finance companies have been advised not to levy any prepayment penalty if the home loan was under floating rate. In case of fixed rate home loan, if the borrower repays from his own resources, housing finance companies still cannot charge any prepayment penalty. For this purpose 'Own Resources' means any source other than by shifting loan to any other bank or housing finance company. Likewise, the RBI has also advised all the banks not to levy any prepayment penalty on floating rate loans. However, for fixed rate loans, the banks can still charge you prepayment penalty.
Lending institutions normally do not charge any prepayment penalty also if the amount prepaid
during the year does not exceed certain percentage of the loan outstanding which is generally 25 per cent. So, in case you are prepaying within the limit, you can do so without having to pay any penalty.
Returns expected from alternative investment avenues available:
While evaluating the option of prepayment of loan, please consider the alternative options available for deployment of surplus funds. In case, the returns expected on such investments are similar as that of the interest on loans, it is advisable not to prepay the loan. Bonds and bond funds scheme of mutual fund houses are like such avenues. The other alternative may be equity oriented schemes of mutual funds in case the money can be invested for more than seven years as the returns on equity oriented funds have been generally good and far better than the rate of interest on home loans for such long tenure. This makes sense looking at the fact that the home loan tenure is generally more than 10 years. You need to compare the post tax rates/returns in to arrive at comparable numbers.
People of old school of thought do not want to have any debt on their house and want it to be free from any debt. This psychological reason is present in significant numbers of cases of prepayment of home loan in India.
How to prepay the home loan
In case you wish to prepay the home loan before its original tenure, you have two options. Either you can start a systematic investment plan (SIP) in equity fund with surplus money you can save in future and continue to do it with increasing the amount of SIP with rising income. As and when value of your investments in such SIPs reaches the amount of the loan outstanding, you can redeem the investments in equity funds, after taking into account the exit load and tax implications, and foreclose the home loan.
The second option is for the people who do not have much of patience. They can use the surplus not immediately required to prepay the home loan and your home loan will get squared up before your original tenure. In my opinion the first option is better as the returns generated by equity funds in the longer rungives better returns than interest rate on your home loan.