PERSONALISED INVESTMENT MANAGERS

Time to Prepay Home - Loan EMIs?

18 October, 2022


          
            Time to Prepay Home - Loan EMIs?

Amid the consecutive rate hikes by RBI, there are news flows explaining the impact on EMIs especially the home loan EMIs. For most middle-class families, a home is one of the biggest investments in their lifetime and most people are on home loans. Loans taken at floating rate of interests!!! It has been a pretty good period till now as interest rates were in a downtrend for the past 5 years. But since the beginning of 2022, they have been on an upward trajectory.

Most people keep home loan as a tax saving instrument because of the tax benefits. But SOME want to get rid of it as soon as possible and be debt-free.

So, is it the right time to prepay your home loan?

Before answering this question, first let us understand how rate hikes impact your home loan.

Home loans are offered with two types of interest rates – floating and fixed. As the names suggest, the interest rate component either changes or remains fixed, depending on the type of loan you have opted for.

How The Rate Hike Affects Your Outflow?

As the repo rate has increased to 5.90 per cent, it will lead to either a longer tenure or higher EMI for home loan borrowers. The default option for banks is to increase the tenure of a loan in a way that the EMIs remain unchanged, but the number of years for payment increases proportionately.

Option Before Rate Hike After Rate Hike of 140 bps
Interest Rate Monthly EMI No. of EMIs Total EMIs Interest Rate Monthly EMI No. of EMIs Total EMIs
A B C B x C A B C B x C
Fixed EMI 7.00% 38,765 240 93,03,587 8.40% 38,765   334 1,29,58,205
Fixed Tenure 7.00% 38,765 240 93,03,587 8.40%   40,075   240 1,03,38,054

₹50 Lakh is assumed as the loan amount. Charges other than interest rate are ignored for ease of understanding.

Should We Prepay the Loan?

Closing or part payment of an existing home loan has multiple variables that you need to consider.

  1. The rate of interest on the loan
  2. The remaining tenure
  3. Opportunity Cost - The rate of return from other competitive investments that you could make
  4. The tax benefits forgone on interest and principal repayment

Foreclosure of Home loan EMIs is not advisable because of available tax advantages. The interest portion of the EMI paid for the year can be claimed as a deduction from your total income up to a maximum of ₹2 lakh under Section 24. From the assessment year 2018-19 onwards, the maximum deduction for interest paid on self-occupied house property is ₹2 lakh. Under section 80C you can claim upto 1.5 Lakhs for principal repayment on the home loan as well.

Equity Investments Vs Home Loan Prepayment

If your investment portfolio is generating higher return than the interest rate on the home loan, it is better to continue your EMIs as is. For e.g. – If you have invested in the equity market through MF and your MF portfolio has an annualized return of >12% as compared to your current home loan rate at 9%, it is better to continue the investment and keep EMIs as is.

But if the interest rate on the home loan is higher than the returns from your investment, it is better to pay-off the loan. For e.g. – If you have invested your entire money in FD at 6% - 7% interest, as compared to your home loan rate at 9%, it is better to withdraw the FD and prepay the loan.

However, the tax benefit of ₹2L as interest on home loan u/s 24B of the IT Act must be considered before deciding how much to pay off. If your interest outgo is more than ₹2L in a financial year, it is better to prepay the principal amount to the extent where the interest liability will be restricted to ₹2L in a financial year.



Home loan EMIs have gone up for almost everyone, regardless of their credit scores, tenures or loan amounts. After three rate hikes by the Reserve Bank of India, various Indian banks and housing finance companies hiked interest rates by as much as 2%, making it dearer to try and own houses. With this new hike, consumers will have to contend with a further 50-bps hike. If one is really interested to get rid of the debt, prepayment could be an ideal choice. New Home buyers should look for an overdraft loan account to earn optimal yield on their savings by reducing interest burden on Home Loans.

Mimi Partha Sarathy
Managing Director,
Sinhasi Consultants Pvt. Ltd.


Current Interest Rates

When the repo rate rises, the borrowing cost for banking institutions rises as well, which is passed on to account holders in the form of higher loan and deposit interest rates. In the current interest rate scenario, the home loan rates are not exorbitant like the one in 2016-17. The expected return from equity is still higher than the prevailing home loan rates. Hence, it is better to continue with the investment and continue the EMIs as it is. Having said that, do remember as well that equity returns are non-linear and only come lumpy in long-term. It remains volatile in short term due to the market risk, economic cycle as well as monetary policy, regulations, tax revisions, or even changes in the interest rates set by a country's central bank.


Conclusion:

In the affordable segment, prepayment may make sense for people who do not need home loan for tax saving. If the customer is not availing of tax breaks, any low-interest income investments should be liquidated to prepay, or part pay the home loan. However, if the surplus fund is provisioned for emergency needs, then you should not utilize this corpus at all although it is earning low yield. Doing so may impact your overall financial health adversely during any contingencies.


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