Factors to consider before choosing a home loan prepayment

Here are four important factors to consider while prepaying your home loan:

factor in your liquidity

While choosing between Equated Monthly Installments (EMIs) and reduced repayment tenure options, you should focus on your liquidity.

Home loan borrowers get two options while making part prepayment of their home loan. They can either reduce their EMIs or reduce the home loan repayment tenure. While interest payments from the latter may increase savings, the decision must factor into your disposable income.

Ratan Choudhary, Home Loan Head, Paisabazaar.com said, “For example, suppose you have taken a home loan. ₹50 lakh approximately five years ago at 8% per annum for a tenure of 20 years. Your current dues will be Rs 43.76 lakh. If you make a lump-sum payment of Rs 6 lakh now and opt for a reduction in tenure, you will save around Rs 11.30 lakh in interest payments, and your loan repayment tenure will be reduced by 41 months. However, if you choose to continue with the same tenure assuming the same interest rate, your EMI will drop ₹from 41,822 ₹36,088 and . generate total interest savings of ₹4.32 lakhs. Thus, opting for the reduction in tenure option will result in greater savings in interest cost.”

Check Home Loan Transfer Option

While home loan prepayment can certainly reduce the net interest cost, doing so by liquidating existing investments can affect financial health. Another option to reduce the interest cost is the home loan balance transfer option, in which another lender takes the existing home loan at a lower rate. This option minimizes interest payments without affecting existing investments and liquidity.

“For example, suppose you have taken a home loan of ₹50 lakh approximately five years ago at 8% per annum for a tenure of 20 years. your current dues will be ₹43.76 lakhs. Now, suppose you have transferred your home loan to another lender at the rate of 7% p.a. for the remaining repayment period of 15 years. In that case, you’ll still manage to save approx. ₹4.48 lakh in interest cost without compromising on its existing investments and liquidity,” explained Chaudhary.

So, compare the savings received through part-prepayment and the savings received through home loan balance transfer and decide based on your financial goals and liquidity.

Avoid drowning in emergency fund

An emergency fund helps with unavoidable expenses. The size of this fund should be sufficient to meet the mandatory expenses of at least six months.

If the funds are used to prepay the home loan, in case of an emergency, one may have to resort to high-interest rate loans or liquidate the existing investments at a loss.

Avoid cashing in on investments tied to your financial goals

Financial goals refer to the monetary expression of essential life goals. Some common examples of financial goals include funding for the child’s higher education/marriage, life after retirement.

Chowdhary said, “Depleting your existing investments for important life goals may lead you to take costly loans later on maturity of such goals. Thus, prepay for home loans only if you have your emergency fund, Have enough surplus keeping in mind the investment and monthly contribution. Keep aside for your unavoidable financial goals.”