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Do's and don'ts to consider when prepaying your home loan

Rohit 
on 06 December 2018

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A home loan is one of the biggest financial commitments anyone can have in their lifetime as the repayment goes on for more than 20 years and even 30 years in some cases. When the tenure is so long and when such a large sum of money is involved, you need to be careful about how you are going to work it out, especially if you are considering prepaying your loan amount. Here, we will list out a few things you need to keep in mind when prepaying your home loan.

What is prepayment of a home loan?

A home loan prepayment is basically the process of repaying the loan way ahead of the tenure. What this does is decrease the interest as well as the overall amount you will need to pay when clearing the loan. Now, without further ado let’s get to a few strategies you can use while preparing your home loan to make the most of it.

Start with a small prepayment amount and increase it gradually

The Reserve Bank of India came up with a directive a few years ago wherein banks aren’t allowed to charge prepayment charges when a borrower prepays their home loan. This goes for both part prepayment and full prepayment of the outstanding amount. In fact, a lot of working professionals are opting to use this strategy and are finishing off with their loan repayment at least 10 years ahead to schedule. So, how you do it? To start off, repay only a small amount at the beginning and increase this amount gradually to clear the loan way ahead of schedule. In order to fund this, you can use the bonuses you get in your workplace as well as the savings you make over the course of a year.

Go for tenure reduction rather than EMI reduction

When you take a home loan, you will be given two options by the bank: tenure reduction and EMI reduction. If you choose tenure reduction, your loan tenure will be cut down over time while the EMI remains the same for the entire period. On the other hand, choosing EMI reduction will bring down the EMI at a certain set juncture of the repayment schedule. To help save more money, you could always choose the tenure reduction plan as the EMI remains consistent and you will clear off the loan comparatively early as opposed to when you choose the other option. Further, this will also allow you to reduce the overall interest you are going to pay on your home loan.

Prepay a fixed amount without reducing the EMI

This is yet another strategy that comes in handy for you when you are prepaying your home loan. The strategy is quite self-explanatory too. What you need to do is keep the prepayment amount consistent and also continue paying the same EMI along with the prepayment. Let’s say you have a loan of Rs.50 lakh, which has an interest of 9% and an EMI of about Rs.44,000 with a 20-year tenure. If you prepay Rs.3 lakh every year for 10 years, while also continuing to pay the EMI, you will finish off the loan in just about 10 years as principal can be brought down considerably by following this system.

Make use of your savings

This is yet another way to prepay your home loan smartly and ahead of schedule. Usually, people have the habit of buying insurance policies when they start working. In case you have an endowment plan that has reached its surrender value, consider breaking it and use the amount to prepay however much you can. Also, if you have an insurance plan which has a higher premium and is offering low returns, consider breaking that as well, and use the proceeds to knock off a few more zeroes off your loan amount.

Things you shouldn’t do when prepaying a loan

While the aforementioned list talked about strategies, here are a few things you shouldn’t do when prepaying your loan.

Don’t ignore the tax benefits

Home loans offer a lot of tax benefits, both for the principal repaid and the interest paid. You can claim deductions to up to Rs.1.5 lakh per year through Section 80C on principal repaid and up to Rs.2 lakh a year on interest repaid. Don’t ignore these benefits, make sure to keep this in mind.

Don’t prepay the entire loan amount at once

When you are looking to prepay your loan, never try to clear off the entire amount in one go. You can use the amount instead to invest in other investment avenues which give you guaranteed returns. Instead, choose to prepay on a yearly basis as you wouldn’t have to shell out too much on tax.

Even something as straightforward as a home loan repayment can fetch you plenty of benefits while also saving you a large sum of money in the bargain. Keeping the above-mentioned ideas can leave you with a lot more money when you finish paying off your home loan.

Hi, I am Rohit. I am writing on finance to help other people so they don't face problems which are very commons. I hope my article helps everyone.


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