As your income increases, you can consider ways to speed up your home loan repayments to get out of debt faster.
Home loans can be granted for terms of up to 30 years. Often, borrowers prefer the longest term possible based on their eligibility. This minimizes the EMI pressure on them and makes it easier to manage their finances. However, the longer the term of your loan, the higher the interest on your loan. Therefore, as your income increases, you can consider ways to accelerate your loan repayments to get out of debt faster. There are several ways to clear your debts. Pre-payment and pre-closing of your loan are two of them.
Pre-closing a loan means paying your dues in one payment. Prepayment means making partial payments on your loan in addition to your EMIs. This saves you interest that you no longer need to pay with EMIs. Your income and savings can thus be diverted towards the achievement of other financial objectives, such as your children’s studies. Pre-closing a home loan can be beneficial for you, provided you do it the right way.
So, let’s find out how you can optimize your pre-payments and pre-closing.
What is pre-closing?
Pre-closing of a home loan means closing the loan before the completion of its effective term. For example, the term of your home loan is 25 years. After paying EMIs for 15 years, your outstanding loan is Rs 10 lakh, and you decide to write a check to the lender for this amount to settle the dues at once. Thus, your loan is pre-closed, that is to say repaid 10 years before its due date. You are debt free and can immediately collect your property documents from the lender.
What is prepayment?
Pre-payment is also a way to gradually pre-close your loan. For example, your EMI is Rs 50,000, but you decide to pay Rs 2 lakh every month. The amount beyond the principal and interest due for that particular month is treated as a prepayment. So, if your principal and interest that month were Rs 17,000 and Rs 33,000 respectively, paying an additional Rs 1.5 lakh for the month makes your total principal payment for the month Rs 1.67 lakh. A regular prepayment will thus speed up the repayment of your loan, helping you to pre-close.
In line with the RBI guideline, banks currently do not charge any pre-closing or pre-payment fees on variable rate home loans. However, lenders may apply simple interest charges.
Refinancing for pre-closing of a mortgage loan
Current home loans taken out a few years ago may attract a higher interest rate than current home loans. If there is a substantial gap between current market rates and your current loan rate, you can refinance it. You can go to your own lender to negotiate a lower rate or transfer your loan to another lender who offers you better terms. A loan balance transfer involves taking out the new loan to pay off and pre-close the old loan.
For example, your current home loan is Rs 50 lakh. The remaining term is 20 years. Your existing bank charges you interest at 8.5%. You have seen that some lenders offer home loans at 6.8% while charging processing fees and other fees of Rs 20,000. What should be your decision? Should you refinance your home loan or stick with your current lender? Let’s check.
So, by refinancing a home loan, you will be able to save interest of about Rs 12.54 lakh in 20 years. Assuming you continue to repay the same EMI after the refinance that you repaid to your previous bank, you would be able to pre-close your loan in 187 months instead of 240. Before transferring the home loan, check the processing fees and other charges levied by the bank for this facility.
Use the windfalls to partially repay the loan
From time to time, you may get extra income through bonuses, benefits, ESOP payouts, inheritance, or other unexpected ways. Instead of spending that income unexpectedly, use it to prepay your home loan. Even if you pay off your loan a little early, it can save you a lot of interest, resulting in a pre-closing. For example, you have a loan balance of Rs 50 lakh with 20 years remaining and an interest rate of 6.8%. Your total interest on these numbers would be Rs 41.60 lakh. However, if you only prepay Rs 5 lakh, your total interest payment would come to Rs 29.58 lakh, a saving of Rs 12.02 lakh.
Set a financial goal for loans
You can provide for an early repayment or a pre-closing of your mortgage by saving for this purpose. You can use your excess monthly income to invest in instruments such as RD or mutual funds or a combination of both to build up a corpus that can be used to repay your loan. You should choose the investment vehicle carefully and focus on earning a return above the prevailing interest rate on your home loan.
Strengthen your NDEs
You can use excess monthly income to increase your EMI. The amount you pay in addition to your dues will be treated as principal payments, which will also act as prepayments and help you pay off your loan sooner. You should periodically increase your EMIs as your income increases. For example, if your starting EMI was Rs 25,000 while your net salary was Rs 60,000, you can increase your EMI to Rs 50,000 if your net salary is now Rs 120,000. is an illustration, and you need to calculate the step-up basis of your financial situation.
Before pre-closing your home loan, you need to assess whether or not it is financially right for you. A home loan is one of the cheapest loan products available on the market, and before you squeeze your cash to pay it back, you should also carefully consider its impact on your tax liability. Getting out of debt is a great place. Use low interest rates, financial planning and regular prepayments to your advantage.
(The author is CEO, BankBazaar.com)
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