WHEN a borrower’s income increases, his capacity to pay over and above his home loan EMI goes up. Opting for pre-payment instead of putting it into other investment assets can prove wise, especially in the current macroeconomic scenario.
WHEN a borrower’s income increases, his capacity to pay over and above his home loan EMI goes up. Opting for pre-payment instead of putting it into other investment assets can prove wise, especially in the current macroeconomic scenario. Lending rates are likely to remain low over the next few quarters in comparison to where the rates were two-three years ago. Therefore, should borrowers pre-pay while interest rates are low, they would reduce their outstanding loan balance at a faster rate. Therefore they will be strongly positioned in their repayment plan whenever interest rates start trending upwards again.
Let’s understand this with an example. Let us look at a typical home loan scenario, wherein the loan amount is R30 lakh, the interest rate is 11% and the tenure is of 240 months. If the home buyer pays regular EMIs for 20 years, the total interest payment on the principal of R30 lakh would be about R44.31 lakh.
Now let’s assume that the borrower decides to pre-pay the loan after five years. At the end of five years, he would have paid R18.58 lakh, out of which, R15.82 lakh would have gone towards the payment of interest while only R2.76 lakh would have gone towards the repayment of principal. The outstanding principal amount would be R27.24 lakh.
So, on prepayment of the entire outstanding principal at the end of five years, one would be able to save about R29 lakh. On prepayment after 10 years, he would be able to save about R15 lakh.
These calculations assume a fixed interest rate. If the borrower pre-paid on a floating interest rate which had come down from 11% to around 8.6% (the prevalent rate now), the savings would be much more significant, since the borrower is paying off a part of the loan at a cheaper rate.
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The borrower had R27,24,418 as loan outstanding from the sixth year, when his loan switched from a fixed rate to a floating one. The floating rate being 8.6%, his EMI has already come down to R26,988. If he pre-paid 10% of his outstanding balance—R2,72,441—his loan tenure would plummet from 180 months to 148. This implies long-term savings from 32 fewer EMIs would be of R8.63 lakh.
The more the borrower is able to pre-pay at a lower interest rate, the more he’s going to save in the long run when the interest rate starts to climb again—which it undoubtedly will.
Is it always good to pre-pay?
You should compare the interest you would earn from an investment instrument with the interest on the home loan before taking a decision. If the alternative investment instrument pays more than the home loan interest, you must opt for it.
Also, consider the tax benefits associated with the home loan principal repayment and interest payment if you stay married to the loan.
The writer is CEO, BankBazaar