- Paying off a home loan before the scheduled finish has massive savings in store for you!
- But how can you do so and what are the challenges you could face? - Read all these and more here
Getting relieved from home loan payments before the scheduled finish gives you more space to spend on your priorities. The large home loan quantum, which is likely to be the case given the surging property prices, keeps the EMI relatively high and makes you pay a massive interest amount to the lender. For example, a home loan of INR 50 lakh for 20 years at an interest rate of 8% per annum leads to overall interest payments worth INR 50,37,281 (approx.), which is more than the principal loan amount.
But if you plan well, you can pay off the loan much before and cut down on interest payments. You might ask, how can I plan and are there any challenges to execute the same?
So, we will first discuss the benefits of home loan payments before time and then focus on how you should go about this. At the last, we will look at the possible challenges. This way, you could understand things better and make the right call. Let’s read on!
Benefits of Paying off a Home Loan Before Time
Paying off a home loan before time is called prepayment in the financial terminology. Above, we have mentioned that it will help reduce your interest obligations. But its benefit is more than that, which you can see below.
Interest Obligations Can Reduce Drastically
As home loans run for a very long time, typically in the range of 15-20 years on average, one could end up paying a huge amount of interest to the lender. And, if your home loan interest rate is more than the average market rate, the overall interest repayment can be way beyond your imagination. But a prepayment will help cut short the length of a home loan and reduce interest payments. An example below will help you understand better.
Example – You have recently taken a home loan of INR 60 lakh at an interest rate of 8.20% per annum. The loan is taken for 20 years. But if you prepay after 14 years, how much will it save for you?
|Loan Aspects||Amount (In INR)|
|EMI Payable @8.20%||50,936|
|Interest Payable @8.20%||62,24,591|
|Interest to be Paid Till 14 Years||54,46,195|
|Outstanding Balance After 14 Years||28,88,981|
|Savings on Paying off the Outstanding Balance||7,78,396 (62,24,591-54,46,195)|
You can see substantial savings of INR 7,78,396 on prepaying the loan after 14 years.
Gives You the Freedom to Think About Other Things
As the loan gets over, you get the space to create more corpus for your retirement days. Often we live in the present and don’t pay attention to securing our future. And, with a home loan allowed to continue until the scheduled finish, you may not get enough time to build the desired retirement corpus. Keeping that in mind, it is advised you pay off the loan earlier than scheduled with smart planning. A retirement will most likely bring active income to a halt. And, if you do not have the right corpus, you might struggle to live peacefully after retirement.
Scope for More Loans Also Enhances
As a big-ticket home loan finishes before the scheduled time, you get the luxury to go for small-sized loans too. With a home loan, the scope for getting a personal loan or car loan reduces to a degree. Lenders offer higher loan amounts when you have No to less existing debt obligations.
But How Can You Plan a Home Loan Prepayment?
As we have said before, a successful home loan prepayment requires smart planning and execution. This is where saving the money diligently and putting it to good use will come handy. Besides utilizing savings optimally, you have other options too to get rid of a home loan quicker. Let’s focus on these.
Save Money Diligently and Choose the Right Source to Make it Big
If you have taken a home loan where the Equated Monthly Installment (EMI) is well below 50% of your net monthly income (NMI), you can save more compared to someone whose loan obligations constitute much higher. But achieving the desired amount over time will require putting the savings in the right financial product too, which we have told before. Before choosing the product, you need to be clear of two things – risk-appetite and investment horizon – apart from your goal of investing for home loan prepayment. You are a good judge of yourself. See how you react to monetary fluctuations and how long you can stay invested.
If you have a greater risk-taking capability and can invest for long, you can put your money in equity mutual funds via a Systematic Investment Plan (SIP). If you have a low-risk appetite, look to divide your investments across fixed deposits and debt mutual funds. Since it’s for home loan prepayment, you need some tranquility in monetary growth. So, even if you are risk-savvy, look to invest a reasonably significant amount in safer instruments. Well, an ideal allocation cannot be given. But if you put 40% in fixed deposits and debt funds and the remaining in equity funds, things can work well for you.
Use Home Loan and investment Calculators to Decide the Right Investment Amount
Use the home loan EMI calculator to check how the repayment will fare over the years. Looking at the calculator, you can figure out the time by which you can accumulate the desired sum for prepayment. This will help you choose the right investment amount, which is as important as choosing the right type of investment.
So, bring out all your investment (mutual funds & fixed deposits) calculators and see how much you need to invest monthly to achieve the home loan prepayment amount. You can use calculators of mutual funds and fixed deposits. The returns of both equity and debt funds are not fixed compared to fixed deposits that assure a fixed income for investors. But market trends suggest that you can get returns of around 12% and 8% on equity and debt fund investments, respectively.
For example, if you require INR 20 lakh over 10 years, an SIP investment of INR 10,000 in equity funds will be enough, assuming the investment grows at an annual rate of 12%. Since there can be fluctuations in the eventual value, you should invest some in debt funds and fixed deposits too.
What If We Tell You to Change Your Approach to Home Loan Prepayment?
Yes, you can adopt different approaches to home loan prepayment. One is accumulating the bulk sum to prepay the loan in full before its original lifetime. The second one is to do a part prepayment. Yes, lenders allow both full and part prepayment of a home loan. You can pay a certain portion of the outstanding balance and go with the same EMI afterward. What will happen then is a reduction in the tenure as well as interest payments? Let’s consider an example to understand the operational methodology better.
Example – You have availed a home loan of INR 50 lakh at 8% for 15 years. Given your present income, you could part pay INR 7 lakh after paying the loan for 8 years. If you do the same and continue to pay the same EMI afterward, how quickly can you get rid of loan obligations? Let’s find out!
|Home Loan Details||Amount (In INR)|
|EMI Payable @8%||47,783|
|Interest Payable @8%||36,00,869|
|Interest Payable Till 8 Years||26,52,826|
|Outstanding Balance After 8 Years||30,65,696|
|Part Payment Amount||7,00,000|
|Outstanding Balance After Making a Part Payment||23,65,696|
|Interest Payable by Keeping the Same EMI After Part Payment||5,12,369|
|Interest Payable Before Part Payment + Interest Payable After Part Payment||31,65,195|
By keeping the same EMI after doing a part payment, you are cutting short the loan tenure by 2 years. So, the loan will run for 13 years in total (8 years before part payment and 5 years after it). Doing this will yield you a savings worth INR 4,35,674 that you must have seen above.
Challenges That You May Face When Looking to Pay Off a Home Loan Before the Scheduled Time
Paying off a home loan before the scheduled finish may not be as straightforward as many would think of. Yes, you might face challenges like the lesser than expected income growth over the years, sustained unemployment, etc. Let’s discuss these now.
Lack of Desired Income Growth
The income growth may not be the same throughout. You could witness some dull periods where there will be no incremental growth in your income. The reasons for this can be many. Either your company may not do well or your performance won’t get considered good enough by your employer to raise your salary. Even if you switch to another job, you may not get the hike you expect, thereby derailing your home loan prepayment plans.
Loss of Employment
Just as there’s no guarantee that you will have good income growth over the years, there’s no assurance that you will have no stoppages in your work life. Yes, you can lose a job for a fairly greater length of time, wherein you might even struggle to pay the home loan EMI. In that case, you will need to either postpone or cancel your prepayment plan.
Rise in Expenses
The thing with expenses is that they only rise with time. You might feel the need to save more for the education of your children. The cost of education is rising at a faster pace. If a 4-year engineering course costs INR 15 lakh in India, look to accumulate keeping in mind the 5% inflation every year. With the home loan EMI presumably taking a huge chunk of your income, you might struggle to accumulate the education corpus sufficiently. In that case, you can go for a part prepayment and leave enough for the education of your kids.
As we have seen the benefits of paying off a home loan before the scheduled finish are massive in terms of savings. But all that depends on how your income and savings fare over the years. If you don’t witness any turbulence, making a home loan prepayment will be a formality for you. However, if the lull period stretches for long and your investment does not yield the desired growth, the possibility of a full prepayment can be ruled out. In that case, you can still go for part payment and reduce your interest payments.