At a time when home loan interest rates are over 9% and likely to remain high till the inflation outlook improves, existing borrowers need to look at various options to prepay the loan periodically and reduce the interest burden without sacrificing their existing investments for achieving crucial financial goals. The Reserve Bank of India in its bi-monthly monetary policy meet has kept the repo rate unchanged at 6.5% for the fourth consecutive time.
A borrower with limited liquidity can prepay one extra EMI every year. Second, he can pay 5% of the loan amount every year. A third option would be to prepay 5% of the loan balance every year (lenders apply monthly reducing balance method for interest calculation). Those with sufficient liquidity can aggressively pay 10% of the loan amount or the outstanding balance to reduce the interest payout significantly.
However, before aggressively prepaying the home loan, a borrower must do the math on the effective interest rate after factoring in the income tax benefits under Sections 80C and 24 B on deductions on the interest of a home loan.
Smart strategy
For example, if an individual has borrowed Rs 50 lakh at 9% for 20 years, then the total interest payout will be around Rs 58 lakh, assuming the interest rate remains the same. If the borrower pre-pays an extra EMI every year, then the total interest payout will be Rs 45 lakh, or savings of Rs 13 lakh and reduction of 45 months of the loan tenure.
Alternatively, if a borrower prepays 5% of the loan amount annually, he will save `35 lakh of interest and the tenure will reduce to 109 months from the original 240. If he prepays 5% of the outstanding balance every year, the savings on interest will be `31.53 lakh and the tenure will come down to 133 months.
An aggressive borrower can opt to prepay 10% of the loan amount every year. This will save him almost `44 lakh of interest and slash the EMI tenure to just 73 months. Alternatively, he can prepay 10% of the outstanding balance every year to save Rs 40.5 lakh of interest.
Adhil Shetty, CEO, Bank-bazaar.com, says it is best to settle the dues while the borrower is in the working phase. “Even a single pre-payment can have a huge impact on your loan tenure. An EMI factors both interest and principal payments. But a pre-payment is counted only against the principal. You can devise a pre-payment plan for yourself to pay off your loan quicker.”
Other options
Those borrowers who have seen significant improvements in their credit profile and repayment capacity can negotiate with their existing lenders for lower interest rates. If their lenders refuse to do so, they should transfer their loan to another lender offering lower rates. The improved credit profile may make them eligible to transfer their existing loans at lower interest rates.
Those opting for home loan balance transfer should opt for shorter tenures with the new lender to further reduce overall interest cost. However, refinancing may involve some costs. So, first calculate whether the savings in interest payments justifies the expenses.
Borrowers can opt for the home saver option, a home loan variant branded by various lenders as Home Loan Advantage, Max-Saver, Maxgain, Money Saver, Smart Save, Super Saver, etc. Under these facilities, the lenders open overdraft accounts for their home loan borrowers in the form of savings or current accounts.
Ratan Chaudhary, business head, Home Loans, Paisabazaar, says borrowers can use these overdraft accounts to park their surpluses and make withdrawals as per their financial needs. “The interest components of their home loan account are calculated after deducting the overdraft account balance from the outstanding home loan amount. Availing this home loan variant will the borrowers to reduce their interest cost while preserving their liquidity,” he says.
When rates start falling
If the borrower can afford to keep the EMI unchanged despite falling interest rates, he must do that. This will allow him to repay the loan faster as more of the EMI goes towards the principal amount. Some borrowers maintain their current EMI and instead reduce the tenure. This can save a significant amount of interest in the long run. However, those with limited repayment capacity can opt for EMI reduction to lower their repayment burden.