You have taken a home loan and suddenly you receive an annual bonus or earned a good profit in business, would you prepay the loan or invest the amount somewhere else. If asked from our older generation they will suggest getting away with the debt as they believe that any kind of debt increases the financial stress and also saves the interest cost. However, home loan are provided at a lower interest rate and also offer tax saving schemes. So, before you take any decision here are a few points which you should keep in mind before taking any decision:-
- Interest Rate Gets Reduced Post Tax
The income tax department of India allows a deduction of up to Rs 1.5 lakh on principal repayment under Section 80C and Rs 2 lakh on the interest paid during the financial year under Section 24. When this is considered the interest rate of home loans gets reduced. People coming in a higher tax bracket of 30 percent will save up to Rs 60,000 and people falling in a bracket of 20 percent and 10 percent can save upto Rs 40,000 and Rs 20,000 respectively. The effective tax rate for a person in the lowest tax bracket will be 7.09 per cent and the second slab will be 7.76 per cent.
- You Will Pay More Interest And Save Less
If you have a home loan of more than Rs 40 lakh, then partial prepayment is a good option because the maximum deduction one can avail on the interest is Rs 2 lakh. This way you will be paying more interest on the principal amount and saving less. Partial prepayment will save and bring down your home loan amount and you can also avail the tax benefits. If you have taken a loan for Rs 30 lakh you can save up to Rs 2 lakh on tax for a few years, with the partial prepayment of a loan with a surplus income you can bring down the loan amount and enjoy tax benefits for a few more years.
- Keep Emergency Fund
Always keep enough funds in your account that could meet your everyday expenses for at least 5-6 months, this rule should be followed by everyone. Keeping an emergency fund is important for unseen conditions like loss of job or medical emergency. Prepaying option will lay off the financial stress but if you don’t have enough funds to meet the day to day expenses then you may end up getting another loan. Pay the loan only if you have surplus funds even after paying off the loan.
- Pay Off Improves Credit Score
Prepayment of the home loan will also help in improving the credit score. It increases the creditworthiness of a person which will make you more eligible for financial transactions, loans or credit cards.
- Invest If You Get A Better Option
If you come across an investment option where you are getting a higher rate of interest then prepayment of a loan does not make sense. But if you are looking to invest in fixed deposits or recurring deposits then it is better to pay off the loan, as the rate of interest on home loann is generally more than deposits return, which are around 7-8 per cent (the post-tax return will come down further depending on the tax slab).
Bottom line: It important to analyse your needs before paying off a home loan. Important factors to keep in mind is that there is nothing called a good debt, it is better to pay off the loan as soon as possible and at times home loan rates are so low that you should be investing any extra money at a higher interest rate. You will have to find a balance between the two to make the right decision.