Home buyers save money on rent by moving from a rented to own home and there are also income tax benefits on the interest paid on a home loan and on the principal repayment as well.
As buying a home requires a large amount of money, very few people can buy one with the entire down payment, and most home buyers need to take out a home loan. There are also some advantages of buying a home by taking a home loan – buyers save money on rent by moving from a rented to own home and there are also income tax benefits on the interest paid on a home loan and on the principal repayment as well.
Home loans are generally cheaper than other loans and repayment periods mostly vary from 15 to 20 years. Some financial institutions are even offering home loans for a repayment period of 30 years.
Even if the rates of interest on home loans are lower, the longer the repayment period, the higher will be the total interest payment, even as the amount of equated monthly installment (EMI) will be lower.
For banks and financial institutions, home loans ensure long-term stable income for 15 to 30 years.
However, during the long repayment period, if a borrower gets some lump sum money or his/her regular income rises substantially, should the extra money be used to repay the ongoing home loan or should it be invested elsewhere to generate wealth?
The decision to repay or invest should be taken on a case to case basis.
When to repay
The decision to repay the entire loan amount or a part of it may be crucial in the following circumstances.
In case there is uncertainty in future earnings due to lack of stability in career, it’s better to reduce future liabilities by repaying home loan early whenever there is an opportunity.
High EMI amount
In case the amount of EMI is very high compared to monthly income – e.g. over 40-50 per cent of salary/income – it’s better to use lump sum money to repay a part of it to reduce the EMI amount.
When to invest
The decision to invest may be taken over the decision to repay on the basis of following factors.
Low interest rate
As interest rates on home loans are generally lower than most other loans, there are scopes to generate higher return through investment.
As the tenures of home loans are over 15 years, a borrower gets a chance to invest in long-term instruments like equity and generate a much higher rate of return compared to the rate of interest on a home loan.
As there are tax benefits up to a limit on home loan interest and principal repayment, it’s better to continue with the repayment schedule to enjoy the benefits instead of repaying in lump sum. Moreover, repaying in lump sum would exceed the limit of tax benefit in the year of excess repayment and curtail the scope of future tax benefits.