It may look difficult to pay back your home loan much before its actual tenure. However, you can simply do it if you carefully plan and use your disposable income. A prepayment is a great tool to close the home loan early, save interest outgo and reduce the EMI obligation.
There are two ways to close our home loan early. You can either prepay the entire outstanding home loan or partially prepay. A full prepayment or foreclosure means complete prepayment of the outstanding loan amount. On the other hand, partial prepayment allows paying a portion of the outstanding loan amount once or multiple times during the loan tenure.
Foreclosure may not be possible for most borrowers especially during the initial period of the home loan. That’s why, they may use the partial prepayment option. Let’s find out options to partially prepay your home loan.
Use Surplus Money To Prepay Home Loan
At the time of taking a home loan, the borrower keeps the EMI below their prevailing financial repayment capacity. However, after a few years of taking the loan, the borrower’s income may increase due to factors like salary hikes. In such cases, the borrower may use the surplus income to prepay the home loan.
The borrower may approach the bank with relevant income documents and request to reduce the loan tenure to increase the EMI obligation. It can help you save a significant amount in interest. Another option is to accumulate the surplus money to create a corpus to periodically prepay home loans. Under loan prepayment, banks offer you the option to reduce the loan repayment tenure or to reduce the EMI, you may decide the best option depending on your income stability and financial comfort.
Use Windfall Gain To Prepay Home Loan
People may get windfall gains in their income due to bonuses from the employer, acquiring wealth from inheritance, etc. If you get such lumpsum amount of money, it can be a good idea to use it to prepay your home loan.
“Before you use the windfall gain to prepay the loan, you must analyse whether it’s better to prepay the home loan or to use the fund for investment. If the return on investment is substantially higher than the interest on the home loan, you may deploy the fund into an investment. However, while comparing the two options, you must take into account factors such as level of risk on such investment, tax benefit you get on home loan interest/principal repayment, tax on return on investment, etc,” says Adhil Shetty, CEO, Bankbazaar.com.
For example, suppose you have received a windfall gain of Rs 5 lakh. Interest on your home loan is 6.5% per annum and at the same time interest on the bank FD is 7% pa. Assuming you fall in the 20% tax bracket, the net return on investment would be approx. 5.6% pa which is lower than the interest applicable on the home loan. So, you may save more money by prepaying the loan.
Save More To Prepay Home Loan
If you want to get rid of home loan repayment obligation sooner than the actual schedule, then you need to plan it in advance. “You can start with changing your spending habit and by focusing on reducing unnecessary expenses. Set your target savings higher than your earlier benchmark. When there is an increase in your income, make sure you also increase your savings target. Once you start saving more and more, you may use that corpus to prepay your home loan and thus close it much before its scheduled date,” says Shetty.
Prepay When Loan Interest Is Low
It makes sense to prepay your home loan when the interest rate is low. Out of your EMI a lower amount goes towards the interest part and greater goes towards reducing the principal portion of the home loan. This happens when your EMI is kept the same despite a change in the interest rate and the tenure is increased.
Let’s understand with the help of an illustration below.
Prepaying home loan when interest is low
So, from the table, it’s clear that in the initial years of the loan, if interest is high, then more money goes towards clearing the interest compared to when the interest rate applicable on the loan is lower. So, “if during the initial years if you prepay a loan when the interest rate is low, then gradually a greater portion of your EMI can go towards reducing the principal portion. If you prepay your home loan when the interest rate is low, you’ll be able to close your home loan quicker as compared to when the interest rate is higher,” informs Shetty.
Prepaying the home loan can free you from the EMI obligation much earlier than the actual schedule. However, you should be careful about your liquidity needs and maintain the sufficient emergency fund while working out this option.