Home loan

The key to making early home loan repayments

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While reducing tenure may guarantee greater savings, reducing the amount of EMI will help increase the overall proportion of disposable income

While reducing tenure may guarantee greater savings, reducing the amount of EMI will help increase the overall proportion of disposable income

Large loan amounts and long repayment terms of up to 30 years make home loans one of the largest financial commitments for any applicant. These factors also drive the cost of interest on home loans to exceed the principal amount in most cases. Therefore, many mortgage borrowers tend to reduce their overall interest costs by making partial prepayments during the loan repayment term. Since most lenders provide home loans at variable interest rates, existing borrowers are not charged prepayment penalties if they partially or fully repay their home loans.

Home borrowers looking to reduce their debt by paying off their existing home loan in whole or in part should keep the following points in mind before opting for home loan prepayments:

EMI or term of loan

Borrowers of existing home loans who opt for prepayments face two options: either minimize the EMI component of their loan or reduce the term of their loan. Although borrowers may realize greater savings on their overall interest costs by reducing the term of their loan, reducing the amount of EMI will increase the overall proportion of borrowers’ disposable income.

Therefore, the decision to choose one or the other option will mainly depend on the willingness of the borrower to reduce the overall cost of interest or to reduce the burden of IMEs in order to undertake future investments and expenditures. .

Balance transfer

The Home Loan Balance Transfer Facility (HLBT) allows existing borrowers to transfer their current home loan to another lender at lower interest rates and/or more favorable terms.

This facility is particularly useful for borrowers with an improved credit profile who can take advantage of a declining interest rate regime to qualify for low interest rate home loans.

Exercise of the HLBT option results in a reduction in the overall interest payment for a borrower without adversely affecting their liquidity or ongoing investments.

Home loan borrowers should consider the estimated overall savings by utilizing the balance transfer facility before opting to transfer their existing loan to another lender.

Existing borrowers looking to transfer their home loan to other banks or housing finance companies (HFCs) may also consider the home loan overdraft option – a variant of home loan – if offered by the new lender. . In this variant, an overdraft account is opened, in the form of a savings account or a current account and attached to the mortgage account.

Home loan borrowers can deposit their excess funds into this overdraft account, from which they can withdraw part or all at a later date in the event of future monetary requirements or shortage of funds.

The balance amount remaining on the overdraft account is deducted from the outstanding home loan amount when calculating the interest component. Thus, the home loan overdraft facility offers a dual benefit of prepayment of the loan and readily available cash for their borrowers.

Emergency fund

Emergency funds are created to meet financial demands and/or to meet unavoidable expenses such as ongoing IMEs, rent, insurance premiums, and school fees for children during times of loss income caused by unemployment, illness or disability.

Emergency funds should ideally be large enough to cover all unavoidable expenses for at least 6 months.

Home borrowers who use their emergency funds or sell assets to make loan prepayments may need to redeem their existing investments at suboptimal prices to weather adverse financial situations or qualify for future loans at lower rates. much higher interest.

Many home loan borrowers tend to liquidate their existing investments intended for crucial financial purposes to make prepayments of home loans.

However, this can negatively impact their liquidity and long-term financial health, in addition to forcing them to resort to more expensive loans in the future just to meet these financial obligations.

Consider yields

Although home loan interest rates are among the lowest among retail lending products, they generally tend to be higher than the returns generated by most fixed income instruments.

Therefore, if home loan borrowers had placed their excess funds in fixed income products such as fixed deposits, short-term debt funds that are not earmarked for a critical financial purpose, they can use them to repay their existing home loans in advance. However, the same strategy may not be applicable in case of equity investments.

Since the long-term returns generated by equity investments are generally much higher than the interest rates of mortgages, one should refrain from redeeming their equity to make prepayments of mortgages.

(The author is Head of Home Loans, Paisabazaar)

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