Early Payment: How to use your surplus money optimally

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September 20, 2021 1:00 AM

As and when you have surplus money, prepay long-term debts such as credit card outstanding, personal, vehicle and housing loans

However, in case of a vehicle loan it is ideal to pay-off with extra cash as a car loan would be at a higher rate of interest than the home loan, with no income tax benefits and, finally a car is definitely a depreciating asset whereas generally a house is an appreciating asset.However, in case of a vehicle loan it is ideal to pay-off with extra cash as a car loan would be at a higher rate of interest than the home loan, with no income tax benefits and, finally a car is definitely a depreciating asset whereas generally a house is an appreciating asset.

At a time when fixed income products are offering lower returns and stock markets remain frothy, individuals should use their surplus money to prepay long-term debts such as credit card outstanding, personal, vehicle and housing loans.

Experts suggest that if an individual can generate higher post-tax returns than the current interest rate on home loan, then he should invest in the surplus money. They suggest that the valuations in equities are stretched and the returns may be muted and investors who start investing in equities now should not expect much higher returns. Before prepaying loans which help in building an asset in the long-run, an individual must ensure adequate emergency funds to cover expenses for a year and adequate life and health insurance cover. If not done, then in case of any emergency, the person may have to take a personal loan, which attracts a much higher rate than a home loan.

However, in case of a vehicle loan it is ideal to pay-off with extra cash as a car loan would be at a higher rate of interest than the home loan, with no income tax benefits and, finally a car is definitely a depreciating asset whereas generally a house is an appreciating asset.

Prepay home loan
As equity investments have given higher returns, one can book profits and prepay a part of the home loan. Experts say the ideal strategy in this bull market is to remain invested with occasional partial profit bookings and moving some profits to fixed income or to prepay loans that have higher interest rates. As the interest rates on home loans have fallen in the past two years, it is ideal to prepay as a hike in the interest rate will put additional burden on the borrower.

Experts suggest if individuals are not in a position to make a lumpsum payment, then they can go for a systematic withdrawal plan from their mutual fund investments and use the monthly proceeds to step up the EMI. Increase in EMI can be requested at any point of time and there are no charges for such a request. Also, for a salaried employee, stepping up EMI helps as the borrower progresses in his career and higher pay packages which will result in higher disposable income.

In a home loan, the interest portion is front-loaded. So, a borrower should start prepaying some amount from the first year of the loan. Prepaying later does not save much in terms of interest payment. Banks do not charge any pre-payment penalty on floating loans and banks will accept prepayment if it is done from their own funds and as a proof will ask for a six month’s bank statement.

Before prepaying home loan one must evaluate the tax benefits on home loan. The Income Tax Act provides tax deduction of interest in case of self-occupied up to Rs 2 lakh and up to Rs 1.5 lakh on principal repayment under Section 80C.

Clear credit card dues
Any surplus money must be utilised to pay off credit card dues. Rolling the credit by paying the minimum amount due is not a good idea as banks charge an interest rate between 35% and 45% per annum, depending on one’s spend, payback and utilisation patterns. In fact, rolling credit is a lot more expensive than even a personal loan, which can be availed at 13-15% per annum.

If one has multiple credit cards, then one should first pay off the dues on the card which charges the highest interest rate. This will reduce the individual’s interest outgo as unpaid dues on cards with higher interest rate will accumulate more interest amount. So, once the credit card bill with the higher interest rate is paid off from surplus money, then he should switch to the card with the least balance pending.

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