Home loan is a long term financial commitment. At the time of borrowing, your income may not be sufficient to service the bigger EMI or you may have other obligations and debts like car loan or personal loan. But once you are done with all other loans or when your income increases, you may be able to service bigger EMIs. That’s when you will start thinking of prepaying your home loan. Each time when you pay some ‘extra’ amount above and beyond your EMI, it will result in reducing the principal outstanding and help you save by reducing the interest portion of the loan.
When you would consider prepaying your home loan:
- If you have a considerable amount of savings
- If your income has increased due to job change or increment or promotion
- If you get a sudden windfall like bonus, lottery or inheritance
Why you would consider prepaying your home loan:
- Mental relief – Psychologically you will feel relieved once the loan is fully paid. Clearing this debt may feel like your way to financial freedom. Finally, you can claim the ownership of your house in its true sense.
- Savings on interest – The extra prepayment that you make will be adjusted towards the principal outstanding. So you will end up paying less interest and thus makes your loan less expensive.
Some people are so focused on foreclosing their home loan that they postpone every major purchase until home loan is fully repaid. They are so determined that they are aggressively pouring every extra rupee coming into their pocket to prepay their home loan to the exclusion of other priorities. There is nothing wrong with trying to reduce your burden but you should also consider the following before using surplus funds to prepay your home loan.
- Have an emergency fund – Don’t use your family and friends as source of your emergency funds. It is generally advisable to set aside at least 6 to 9 months expenses as an emergency fund. Life is uncertain and in times of need, it comes in handy. The covid-19 pandemic must have taught many people the importance of having an emergency fund. In case of job loss or salary cut, it will come to your rescue. Creating an emergency fund with your surplus money should be your first priority. Never use your emergency fund to prepay your loan.
- Purchase health and term insurance if not already done. Never ignore this one common advice given by all financial advisors. Term insurance will help your family in case of any eventuality.
- Consider the impact on lifestyle – If you start paying your home loan too aggressively, it may impact your lifestyle also. If all your income goes towards servicing your loan then you may have to start penny pinching. Indefinitely postponing all other plans such as family vacation, purchasing home appliances/essentials or much needed home repairs/renovations is not advisable. Your obsession to pay down your debt aggressively should not compromise your family’s needs.
- Should you invest instead? – Comparatively, home loan is the cheapest loan available and it becomes even less expensive after factoring in the tax benefits. If the return you get on your investment is more than the interest you are paying on your outstanding loan, then it is better to invest rather than prepaying the loan. However, such opportunities are usually rare.
- Consider the impact on other financial goals – Every family/person has different financial goals like saving for children’s higher education, one’s own retirement etc. Every year you have to set aside a certain amount for these goals. Often, people think that they will start saving for these goals once they are done with their loan. When you are still in your 30’s and 40’s, it may look like a far away destination. But then you will miss out on the magic of compounding. Also, having a longer horizon will enable you to withstand the market volatility and tide over it.
- Prepay higher interest loans first – It makes financial sense to pay off your more expensive loans first like personal loan and any outstanding credit card dues.
We are not discouraging you from prepaying your home loan. Your life and lifestyle should not be stressed too much about clearing the debt. Rather, nurturing good financial habits will eventually help you to clear your burden along with accumulating enough funds for other financial goals of life. Our prepayment calculator may help you with calculating what-if scenarios.
Note: Usually, there is no prepayment charge on home loan. But ‘terms and conditions’ regarding prepayment may vary from bank to bank. So check with your bank before taking any decisions in this regard.
- When Is a Good Time to Part Prepay a Home Loan?
- Using Annual Bonus to Prepay Home Loan
- How Small Prepayments Can Save You a Number of EMIs?