Skip to main content

Should you pre-pay that home loan?- guide for India

Have some surplus funds and in two minds about how best to use it? Yes, you can invest in tax-free bonds offering attractive interest rates of about 8.7 per cent. But what about your home loan on which the interest rate has been galloping? We offer four tips on how to make the choice.
Suppose you have a joint loan of Rs. 30 lakh at 10.5 per cent with a tenure of 20 years remaining.

KEEP THE EMI STEADY

You now have surplus funds of Rs. 1 lakh and are in the 20 per cent tax bracket.
By prepaying Rs. 1 lakh, you can reduce the monthly EMI by Rs. 1,000 – from around Rs. 30,000 to Rs.29,000. In this case, the term remains 20 years and the interest paid through the life of the loan works out to Rs. 40 lakh.
However, if you pre-pay, but opt to retain the same EMI, the loan could be paid off in 18 years. Total interest paid then reduces to Rs. 35 lakh.
The original loan would have incurred a total interest expense of around Rs. 42 lakh. Prepaying and keeping the tenure at 20 years saves Rs. 2 lakh compared to a saving of Rs. 7 lakh if you reduce the tenure.
It helps to reduce the loan’s tenure because every month, a portion of the monthly payment goes towards paying down the principal.
The decreasing loan balance helps reduce the total interest cost.

TAX DOESN’T MATTER

The interest paid on the home loan qualifies for tax deduction up to Rs. 1.5 lakh per person. Thus, when you take on a 10.5 per cent loan, you may actually pay only 7.35 per cent, after availing the tax deduction in the 30 per cent bracket.
But no matter what your tax slab is, prepaying is the best option for you, rather than investing in a tax-free bond.
Over a 20-year period, income from the bond, which includes annual interest and reinvestment, works out around Rs. 3.6 lakh. Prepayment provides a saving of around Rs. 5 lakh in interest payments after accounting for taxes.
For someone in a 30 per cent tax bracket, income from the bond would be Rs. 3.3 lakh and prepayment helps reduce interest costs by Rs. 4.3 lakh. Hence, prepayment is better than tax-free bonds even for those in higher tax brackets.

WHEN NOT TO PRE-PAY

But there are certain situations when you must hang on and not prepay your loan. If you have just a few years left on your loan, you may be better off investing the amount, instead of prepaying.
For instance, for a ten-year loan, the bond investment offers Rs. 1.2 lakh income, while repayment saves you Rs. 1.4 lakh. Repayment is still slightly better, but the benefits decline as the loan period shortens. And what if interest rates come down? A comparison of the two options shows that you will be better off prepaying the loan, until the home loan rate falls to 8.5 per cent.
Anything lower and you must buy those tax-free bonds.

(This article was published on September 30, 2013)

http://www.thehindubusinessline.com/money-wise/should-you-prepay-that-home-loan/article5185931.ece

Comments

Popular posts from this blog

Best IELTS and English language training institutions in Hyderabad

IELTS stands for International English Language Testing System. As the name implies it is basically an English test for testing the proficiency of the language in an individual.  Training for IELTS can be taken to pass the IELTS exam or to develop good english language skills. I am giving the training institute addresses for Hyderabad. The test system is jointly managed by the British Council,IDP education ltd and University of Cambridge ESOL Examinations and more than 1 million candidates are taking the exam all over the world. The test has two versions : 1. Academic 2. General training Academic  version is for people who plan to continue their higher education by enrolling in universities in countries like US,UK,Australia,Canada,New Zealand etc.The academic institutions in these countries consider the IELTS score as a criteria for the admission process. General training is mostly for immigration purposes in countries like Australia,New Zealand,Canada etc. It may ...

How to use home loans most effectively for tax benefits

1) Deduction on interest: If you are paying EMIs for a home loan you took to buy a house, the interest component in the EMI can be claimed as deduction. You must be both an owner and a co-borrower (in the loan) to claim tax benefits. This deduction can be claimed starting the year in which the construction of the house is completed. Suppose the construction of your house was completed on August 30, 2014, you can claim deduction for interest for the entire 12 months in financial year 2014-15. So every year a maximum of Rs. 2 lakh can be claimed for a house that you use for your own residence. If your house is rented, the entire interest for the year can be claimed as deduction. The interest payments for the year shall result in a loss under the head 'income from house property'. This loss can be adjusted against in the same year against other heads of income in your income tax return including salary. Therefore, it reduces your total taxable income and the tax you pay thereon. A...

Intellectual battle against ISIS as important as Military: Sheikh Makhtoum of Dubai

The global financial crisis taught the world how profoundly interdependent our economies have become. In today's crisis of extremism, we must recognize that we are just as interdependent for our security, as is clear in the current struggle to defeat ISIS. Mohammed bin Rashid Al Maktoum, VP and prime minister of the UAE, ruler of Dubai If we are to prevent ISIS from teaching us this lesson the hard way, we must acknowledge that we cannot extinguish the fires of fanaticism by force alone. The world must unite behind a holistic drive to discredit the ideology that gives extremists their power, and to restore hope and dignity to those whom they would recruit. ISIS certainly can – and will – be defeated militarily by the international coalition that is now assembling and which the UAE is actively supporting. But military containment is only a partial solution. Lasting peace requires three other ingredients: winning the battle of ideas; upgrading weak governance; and ...