Deciding to pay off a large part of one’s property loan in advance may be a very good idea, as it would help you to reduce the payment of interest due on this huge liability and in addition, get rid of the loan faster. However, it is a decision that one must make with caution as there are many factors to be taken into account before doing so.
The immediate concern here is the RBI’s move to omit prepayment charges on home loans in such a way that they are free from any compulsion. that form is a big relief for those who aim to close their housing loans early since the duration can be very long, usually up to 20 years. However, allow me first to break the ice by highlighting 5 essential points to you:
Pre-close your home loan: 5 essential points
- Foreclosure Charges
It is not necessary to prepay floating-rate loans, with prepayment charges being abolished by the RBI. However, many banks and housing finance companies charge foreclosure fees on fixed-rate home loans, varying between 2-5% of the outstanding loan amount. In this scenario, a 3 % charge on ₹20 lakh in an outstanding balance results in ₹60,000 more spent. Always read the loan agreement carefully to know what charges are to be levied on your loan type. - Affect Your Credit Score
Prepaying your home loan can reduce your debt burden, but improving your credit score isn’t the only way to elevate it. Credit bureaus appreciate long-term responsible repayment patterns. Moreover, cramming two or three changes into your loan’s repayment routine makes up a mix that isn’t good for your credit score. The only way to know what will happen to your credit score by making a change is to analyze it before making a decision. - Loss of Tax Benefits
Homeowners can enjoy several tax exemptions from both Sections 80C and 24(b) of the Income Tax Act by drawing loans like house loans. Tax deduction of ₹1.5 lakh is available annually under Section 80C on payment of principal dues, while under Section 24(b), there is a provision for interest exemption of ₹2 lakh per year on self-occupied properties. When you prematurely close the loan account, you just lose access to these benefits. For example, if the principal amount becomes ₹2 lakh per year and you are deducting it under 80C, you stand to lose a lot in taxes in premature closure. It is important to decide and calculate the possible tax implications beforehand. - Pre-Endowment Opportunity Cost
The use of savings for pre-closure can save the amount on interest, but in the future, it may also take away the opportunity of getting better returns through investments. As an illustration, if your home loan rate goes up to 7.50% but you acquire profits of around 12%, then you’d get a better bang for your buck investing elsewhere. Imagine ₹ 10 lakhs put into a mutual fund that gives 12% per year, grows online to ₹ 31 lakh in ten years. That’s way bigger than the interest you’d save by closing off the loan early, wouldn’t you say? Look at the opportunity cost again; it’s worth the effort. - Risk of emergency fund Prosperity
Without any proper financial planning, the possibility of fund shortage during those unforeseeable and uncalculated emergencies has very bad consequences. If you have used ₹5 lakh of your savings in closing your loan, and a few months later you face a medical emergency, without adequate funds, you’d approach another loan, which in yet other words would mean further liabilities. Consequently, the borrower must ensure that an emergency fund adequately covers 6-12 months of expenses depending on whether he or she is planning to pre-close a loan.