Home loan borrowers are often in a hurry to prepay their loan. But how easy is it to clear the huge debt well ahead of schedule?
Even before they bought their first house in Jaipur in 2008, investment banker Yash Jain and his wife Namrata were determined to repay the Rs 25-lakh loan well before its tenure of 20 years ended.
They stuck to their plan and prepaid the loan within four years, without choking cash flows. “We used our yearly bonuses of Rs 2.2 lakh, incentives of Rs 65,000 as well as monthly surpluses to make part payments regularly,” Jain explains. In the process, the couple saved an estimated Rs 21 lakh in interest.
The couple’s approach is not unique. While prepaying large home loans may seem a mammoth task, with a little bit of planning and a lot of discipline, it is not a difficult target to meet. “Around 65-70% of home loans are repaid in seven to nine years,” says Vipul Patel, Founder, Mortgageworld, a loan consultancy firm.
Power of part payment
You don’t have to wait for a windfall to prepay a loan. Small but regular payments can go a long way in chipping away the loan tenure. “Those who buy a home in their late 20s or early 30s are often able to clear their loans in seven to eight years as annual increments and bonuses keep increasing, leaving them with adequate surplus,” says Puneet Oberoi, Founder, Excellent Investment Advisorz.
This is exactly what the Jains did. In 2008, their joint annual income was over Rs 14.40 lakh and their loan EMI and rent for their Mumbai flat worked out to Rs 21,000 and Rs 22,000 respectively. Their monthly household expenses amounted to Rs 50,000. Curbing the tendency to splurge ensured that lump sum receipts were put to good use without disturbing their retirement planning.
In Pic: Yash Jain 37, Mumbai
Interest saved: Rs 21.08 lakh
Loan taken: Rs 25 lakh in August 2008
Original loan tenure: 240 months
EMI: Rs 21,000
Projected interest outgo: Rs 25.41 lakh
Loan repaid in: July 2012 or 48 months
Interest paid : Rs 4.33 lakh
How they did it: Used bonuses, incentives and monthly surpluses to make regular part payments.
In 2014, the couple invested in a residential property in Hyderabad and later a commercial property in Bhopal, funding both through savings, sale proceeds of the Jaipur property as well as a plot of land the family owned. Today, the investments fetch the couple a rent of Rs 40,000 per month. Directing any lump sum inflow towards prepayment is key.
Noida-based chartered accountant Amardeep Singhal used lump sum payments he received to reduce his home loan outstanding from Rs 33 lakh to Rs 18 lakh. “I received arrears from clients in two tranches of Rs 10 lakh and Rs 5 lakh in 2016. I decided to use this to reduce my loan burden so that I can pay it off as soon as possible,” says Singhal. His decision entailed a compromise—putting off buying a car.
In Pic: Amardeep Singhal 39, Delhi
Interest saved: Rs 18.06 lakh
Loan taken: Rs 33 lakh in Sept 2013
Original loan tenure: 240 months
EMI: Rs 34,000
Projected interest outgo: Rs 48.6 lakh
Loan partly prepaid in: 36 months
Amount prepaid: Rs 15 lakh
Interest paid : Rs 10.63 lakh
Interest payable over remaining tenure : Rs 19.91 lakh
New EMI: Rs 17, 750
How he did it: Used lump sum payments that he received to make part payments.
“While making prepayments, prefer tenure reduction over EMI reduction as the former will lead to greater savings in interest cost,” says Naveen Kukreja, Co-founder and CEO, Paisabazaar.com. A home loan of Rs 50 lakh with an interest rate of 9% and a 20-year tenure can be paid off within 9.3 years by making a prepayment of Rs 3 lakh at the end of every 12th EMI while keeping the EMI constant (see Scenario 2 graphic).
Start with a small amount as part payment and increase it gradually
The first prepayment is made in the seventh month after taking the loan; subsequently, prepayments go up at the rate of 10% on the back of bonus and monthly savings and are paid every six months.
Prepay a fixed amount every year without reducing the EMI
For a Rs 50-lakh loan carrying a 9% interest rate and original tenure of 20 years; EMI is Rs 44,986 (Rs 5.40 lakh per annum), which is maintained despite continued reduction in principal; a fixed sum of Rs 3 lakh is paid every year till the loan is repaid
Source: Mortgage World
Patel, however, recommends starting small and increasing the prepayment amount by 10% every six months. “A huge pre-payment—constant over several years —is not realistic,” he says. According to him, people tend to use their savings to first repay family members who might have extended financial support. Also, savings are unlikely to be high given that they have to spend on furnishing the house. They can gradually increase the prepayment amount in subsequent years in line with rise in salary and incentives,” he explains. Following such a strategy can cut down your tenure from 20 to nine years for a Rs 50-lakh loan at 9% interest (see Scenario 1 graphic).
Bank on savings
Mumbai resident Rohit Mehta had planned to arrange funds for buying a house and repay it at the earliest before he took a loan of Rs 20 lakh. “I did not use all my accumulated savings. After taking the loan, I used the amount to make part-prepayments of Rs 15 lakh through the period,” he says.
In Pic: Rohit Mehta 34, Mumbai
Interest saved: Rs 9.31 lakh
Loan taken: Rs 20 lakh in May 2016
Original loan tenure: 120 months
EMI: Rs 26,000
Projected interest outgo: Rs 11.2 lakh
Loan repaid in: February 2018 or 22 months
Interest paid: Rs 1.89 lakh
How he did it: Used accumulated savings to make part-payments.
If you haven’t planned as efficiently as Mehta, do not despair. “Often we find people buy endowment or money-back policies during the initial years of their careers and keep paying premiums despite these products not giving good returns. They can dig into their portfolio and look for such policies,” says Tejal Gandhi, Founder, Money Matters, a financial planning firm. If they have acquired surrender value, consider terminating them. The proceeds can be used to make prepayments. “If the premiums are high and returns low, carry out a cost-benefit analysis to check if you can let go of the policy. The amount directed to premiums can come in handy for prepayment or bolstering your cash flows,” she adds. Old investments can also be unearthed and liquidated to make prepayments.
Increase EMI, reduce tenure
If you neither have accumulated savings nor funds, you can still prepay the loan before time. “If a borrower with a Rs 50-lakh loan at an interest rate of 9% and tenure of 20 years decides to increase the EMI by 15% annually, the loan can be closed in the 97th month,” says Patel. If increasing the EMIs by 10-15% looks difficult, you must at least ensure that rate hikes do not extend your tenure. “When interest rates go up, don’t extend the tenure, but maintain or, rather, increase the EMI amount.
In case rates are reduced, opt for a shorter tenure instead of reducing EMI. This will help you pay off the loan faster,” says Nirmal Rewaria, Co-founder, Finpeace Technologies. For example, if the interest rate on a Rs 50-lakh loan with a 20-year tenure rises from 9% to 9.5% after the first month of disbursement. If the EMI is kept at Rs 44,986, the tenure will get extended by two years and three months. “But if you hike the EMI by just Rs 1,565, the loan will end in 20 years,” he adds.
Don’t ignore other goals
While prepayment can ensure peace of mind, do not ignore other goals. “Many borrowers get obsessed with prepaying the loan as soon as possible. We advise them to focus on other goals like retirement and children’s education,” says Gandhi. You also need to take stock of your property investment and take a call to sell it if it is draining your resources.
In 2015, New Delhi-based consultant Gurpreet Singh Saluja decided to sell of his property purchased in 2010 when the interest burden increased. “My initial interest was 8.5% that later increased to 10%. I decided I was better off prepaying that loan and investing in mutual funds.” Initially, he tapped his bonus and surplus to make a part-prepayment. “I finally sold off the property to pay off the loan, and since then, I have been using my savings to invest through mutual funds for various goals,” he adds.
The tax conundrum
Some borrowers hold on to their home loan to gain from tax breaks—up to Rs 1.5 lakh under Section 80C on principal repaid and and Rs 2 lakh on interest paid. But others like Mehta see the benefits of prepayment. “I carried out a cost-benefit analysis and realised that tax breaks translated into savings of Rs 60,000 a year, while my interest outgo was Rs 1.8 lakh a year. It was better to clear the loan and direct my savings into more remunerative avenues,” says Mehta. Experts remain divided. Rewaria suggests structuring the prepayment so that you retain the amount required to claim tax benefits. “Work out a middle path so that you make a part payment and continue to avail tax benefits on the balance,” advises Oberoi.
However, voices against this approach are strong too. “Paying interest to save tax is not a good idea. If the amount paid as interest were to be invested in other financial instruments, they would deliver a much higher yield. It is wise to retire the debt early,” contends Patel. You will have to take a call based on the other investment avenues you are considering. “My property did not appreciate much, and I felt channelling the investment into equity funds would yield better returns,” says Saluja.
The strategy has worked well for him. Also account for your future needs. “Tax saved will always be lower than interest cost. Thus, refraining from prepayment to avail tax breaks is a wrong approach. Consider your liquidity and investments. Sacrificing liquidity and existing investments to make prepayments may force you to avail costlier loans later to meet financial exigencies,” says Kukreja.[“Source-economictimes”]