As your income increases, you can consider ways to accelerate your home loan payments to get out of debt faster.
Home loans can be availed for tenures of up to 30 years. Often, borrowers prefer the longest possible tenure based on their eligibility. This minimizes the EMI pressure on them and makes it easier for them to manage their finances. However, the longer your loan tenure, the higher your loan interest. Therefore, as your income increases, you can consider ways to accelerate your loan payments to get out of debt faster. There are several ways to clear your debts. Pre-paying and pre-closing your loan are two.
Pre-closing a loan means clearing off your dues with a single payment. Pre-payment means making part payments on your loan over and above your EMIs. This saves you interest you no longer need to pay along with EMIs. Your income and savings can thus be diverted to the achievement of other financial goals, such as your children’s education. Pre-closing a home loan can be beneficial for you, provided you do it in the right way.
So, let’s find out how you can optimize your pre-payments and pre-closure.
What Is Pre-Closure?
Pre-closing a home loan means closing the loan before the completion of its actual tenure. For example, your home loan tenure is 25 years. After paying EMIs for 15 years, your outstanding loan is Rs 10 lakh, and you decide to write the lender a cheque for this amount to clear off the dues in one shot. Thus, your loan is pre-closed, i.e., paid off 10 years before its time. You are debt-free, and you can immediately reclaim your property documents from the lender.
What Is Pre-Payment?
Pre-payment is also a way to gradually pre-close your loan. For example, your EMI is Rs 50,000, but you decide to pay Rs 2 lakh every month. The amount over and above the principal and interest due for that particular month is treated as pre-payment. So if your principal and interest that month were Rs 17,000 and Rs 33,000 respectively, paying an additional Rs 1.5 lakh for the month makes your total principal payment for the month Rs 1.67 lakh. Regular pre-payment will thus accelerate your loan payment, helping you pre-close.
As per the RBI’s guideline, banks currently do not charge any pre-closure or pre-payment charges on floating rate home loans. However, lenders may apply simple interest charges.
Refinancing To Pre-close Home Loan
Ongoing home loans that were taken some years ago may be attracting a higher rate of interest compared to home loans being disbursed now. If there’s a substantial gap in the market rates now and the rate on your ongoing loan, you may refinance it. You can approach your own lender to bargain for a lower rate or transfer your loan to another lender offering you better terms. A loan balance transfer involves taking the new loan to pay off and pre-close the old loan.
For example, your home loan outstanding is Rs 50 lakh. The remaining tenure is 20 years. Your existing bank is charging you interest at 8.5%. You saw that some lenders are offering home loans at 6.8% while charging processing and other fees of Rs 20,000. What should be your decision? Should you refinance your home loan or stick to your existing lender? Let’s check out.
So, by refinancing a home loan, you’ll be able to save interest of around Rs 12.54 lakh in 20 years. Suppose you continue to repay the same EMI after refinancing that you were repaying to your earlier bank, you would be able to pre-close your loan in 187 months instead of 240. Before transferring the home loan, check out the processing fee and other charges levied by the bank for such facility.
Use windfalls to Part-Pay Loan
Once in a while, you may get additional income through bonus, profits, ESOP payments, inheritance, or other unexpected means. Instead of spending such incomes in an unplanned way, use them to pre-pay your home loan. Even if you pre-pay your loan a little, it can save you a lot of interest, leading to pre-closure. For example, you have a loan balance of Rs 50 lakh with 20 years left and an interest rate of 6.8%. Your total interest on these numbers would be Rs 41.60 lakh. However, if you pre-pay just Rs 5 lakh, your total interest payment would come down to Rs 29.58 lakh, i.e., a saving of Rs 12.02 lakh.
Setting A Financial Goal For Loans
You may plan pre-payment or a pre-closure of your home loan by saving money for this purpose. You can use your surplus monthly income to invest in instruments like RD or mutual funds or a combination of both to build a corpus that can be used to pay off your loan. You should choose investment instrument carefully and focus on earning a higher return than the prevailing interest rate on your home loan.
Stepping Up Your EMIs
You may use the surplus monthly income to increase your EMI. The amount you pay over and above your dues will be treated as principal payments, which will also act as pre-payments and help you pay off your loan sooner. You should step up your EMIs periodically in line with your rising income. For example, if your starting EMI was Rs 25,000 while your take-home pay was Rs 60,000, you can increase your EMI to Rs 50,000 if your take-home pay is now Rs 120,000. Of course, this is an illustration, and you must calculate the step-up basis your financial circumstances.
Before pre-closing your home loan, you should assess whether it suits you financially or not. Home loan is one of the cheapest loan products available in the market, and before you squeeze your liquidity to repay it, you should carefully study its impact on your tax liability as well. Getting out of debt is a great place to be. Do use the low interest rates, financial planning, and regular pre-payments to your advantage.
(The writer is CEO, BankBazaar.com)