Applying for a home loan helps in meeting the financial needs that arise while buying a house. It offers many advantages for an individual, including tax benefits. However, home loans are long-term loans that individuals repay over a certain period. While dealing with a major financial obligation when servicing a home loan, borrowers face an additional burden on their finances when lenders increase interest rates.
Financial experts say that when interest rates increase, banks typically increase the loan tenure instead of EMIs. In December 2022, the Reserve Bank of India (RBI) increased the repo rate by 35 basis points, and this will directly result in a hike in interest rates by banks and other financial institutions. If your bank increases the interest rate, you are most likely to pay the same amount towards your EMIs, but the loan tenure may increase. For example, if you have taken a home loan today for 20 years, at a rate of 6.7%, it may result in an addition of 149 EMIs, taking the loan tenure to 33 years.
In this scenario, many experts suggest prepayment of home loan. Many home loan borrowers consider repayment as a viable option. However, a decision must be made after careful consideration.
See also: Nine myths about home loans in India
What is prepayment of home loan?
Prepayment refers to the early repayment of the loan amount to the lender. Prepaying an additional EMI at the beginning of every year reduces the overall interest component. One can prepay the loan through part prepayment or making a full prepayment and close the loan account.
Part prepayment
Part prepayments help one to pay back the loan amount intermittently. That is, if you have received surplus funds, maybe as a bonus from your company or through property inheritance, you can consider making a part prepayment that may be a beneficial move. It will bring down the total repayment amount you are required to pay while reducing your loan tenure. Suppose you have a home loan of Rs 20 Lakh. You can pay off Rs 5 Lakh as part prepayment, which will lower the burden on your finances.
Full prepayment
Home loan borrowers also have the option to foreclose their loans by repaying the full outstanding amount to the lender and closing the account before the tenure ends. However, there are additional charges levied by banks, and one may also have to forgo the tax benefits when making a full prepayment.
Home loan balance transfer
Through home loan balance transfer, borrowers get the facility to transfer their home loan to another lending institution at a lower interest rate or better terms and conditions. A borrower is eligible to avail of a home loan at much lower rate, based on his credit profile, and lower the impact of the interest cost.
Why prepaying a home loan may be beneficial?
Experts say in the initial years of servicing a home loan, a significant portion of your EMI goes towards the interest component. Hence, a substantial amount paid through prepayment will help you become debt free early. If you are considering prepayment, it is important to note that banks and financial institutions do not charge any prepayment fee for floating-rate home loans. However, they levy a specified fee for fixed-rate loans.
The reduction in loan tenure is one of the main advantages of loan prepayment. Most financial experts consider prepaying a wise move, considering it reduces one’s financial burden in long run.
Borrowers are faced with a typical situation where lenders ask them to make a choice between reduction in loan tenure or EMI. Lowering the financial burden of EMIs through prepayment can help prospective buyers deal with the rising interest rates. Using surplus funds available to pay off the loan early is a smart approach.
Harini is a content management professional with over 12 years of experience. She has contributed articles for various domains, including real estate, finance, health and travel insurance and e-governance. She has in-depth experience in writing well-researched articles on property trends, infrastructure, taxation, real estate projects and related topics. A Bachelor of Science with Honours in Physics, Harini prefers reading motivational books and keeping abreast of the latest developments in the real estate sector.
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