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Simar Nagi | 24 Jan 2023

3 Important Factors to Consider Before Prepaying a Home Loan

3 Important Factors to Consider Before Prepaying a Home Loan

The time of the year has started when you will get a substantial amount as your annual bonus. Some of you might even think of investing, whereas others might think of spending. But what about those who have home loans to serve? Should the decision be taken with a calm mind to prepay the loan amount or not?  

Lenders don’t make money unless you pay the interest, so the best thing you being a borrower, can do is prepay your home loan. One brilliant way to save money is to close the loans early, either by small or regular prepayments. But just because this suits one borrower doesn’t mean prepaying method will suit another borrower. Maybe with some people, the issue of limited income affects the education of their children or their dream to buy a home or anything else. 

But if you can go by prepaying a home loan, you should do it as it will reduce the burden of the overall cost of the property. Whenever you prepay a loan, it directly reflects a reduction on your current outstanding principal amount. There are usually two possible outcomes when you prepay- the lower interest part and the higher principal part in the next EMI. This means you can reduce the interest substantially for the leftover tenure of the loan and see the principal getting repaid faster. When you see the final result of the prepayment, you will observe that the loan got closed earlier than you expected. 

Let’s try to understand with a simple example-

Imagine you have a home loan left of Rs 1 crore and a time period is given of 30 years on which you are giving an interest rate of 7% p.a. If, by the same rate of interest, you pay your loan tenure, you will be paying Rs 2.4 crore as interest and the principal amount at the end of 30 years. 

In case of prepayment- if you somehow managed to do a part prepayment of Rs 2lakh at the end of the third year, it will result in your repayment going down to Rs 2.29 crore. By adopting a prepayment method, you are saving yourself from around Rs 11 lakh by paying Rs 2lakh in prepayments and reducing your loan tenure. 

Many banks and housing finance companies don’t charge any kind of prepayment penalty on a floating rate on home loans. Even the small cost charged towards a simple interest rate can be diminished by making the prepayment early. Financial institutions ask for at least three times the EMI amount, so before you decide to part prepayment of home loan, get ready to complete information with respect to its terms and conditions. It will be ideal if you repay a home loan in prepayment to become debt-free and cater to other financial goals. 

All in all, you will enjoy savings on huge interest expenditure, reduction of the principal outstanding amount, financial stability, and effect on credit ratings once you decide on prepaying your home loan. 

Few factors that one needs to consider before prepaying a home loan

There are different aspects that you can consider before making part-prepayments-

1. Keep emergency funds aside

You work and develop your emergency fund in order to deal with unforeseen financial crises like medical emergencies, unemployment, etc.; if you plan on using an emergency fund to prepay your home loan, then you will defeat the purpose of an emergency fund. And later, this act of yours might force you to take another loan at a higher rate. Therefore, it is advisable to keep track that you are well stocked on your emergency fund and not exploiting them on home loan prepayments. 

Also read: 6 Important Things to Keep in Mind Before Investing in Real Estate

2. Never utilize your existing investments. 

The criteria for financial success differ from person to person. Maybe some of you are saving for your child’s education, whereas others are for higher education or arranging a down payment for a loan against property. Now that retail loans require a down payment to avail the loan, it does require a lot of effort and steady investment. If you redeem your existing investments on a home loan, prepayments might put you in a position to availing loans at a higher interest rate in the future. 

3. Evaluate which is better - loan tenure or EMI reduction. 

You will have two options to consider for home loan prepayments. You can either bring down the existing EMIs or lower the tenure on the home loan. If you choose to reduce your loan tenure, you might get greater savings in interest payout. It all depends upon your income. 

Dreaming of a perfect home is very hard to fulfil. You very well know that putting yourself on a home loan will involve a long-term commitment. When choosing a lender, get the thorough details of the prepayment and the policies along with them. 

Also Read: EMI Calculator


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