Loan is a burden, prepay it with spare cash

Have a question on home loans? Expert Harsh Roongta tips you off with smart strategies on how to manage your loans.

Question: I have taken a house on loan and have been paying the EMIs, regularly. Now I have a balance loan amount of Rs 7, 00,000 to be paid. The yearly interest outgo is Rs 75, 000 per annum and the loan tenure left is approximately 6 years. Now, I have enough money in my account to re-pay the pending loan amount. Could you advice me, which option is better -- repaying the loan amount or continuing with EMI payouts?

Harsh Roongta: It is always better to prepay your loan if you have spare money.

Having said that, some circumstances may force you to think otherwise. Here are a few tips to help you with this tricky decision.

Tip 1: Before you prepay, keep some money invested in modes that can be liquidated easily for unforeseen contingencies. Once you prepay a loan, this money cannot be borrowed back, easily at a later date.

Tip 2: If you have any unsecured debt (credit card or personal loan), pay it off at once. No risk-free investment can ever give you a post tax return that will be higher than the post tax cost of such a loan. The difference is normally so high that even stiff prepayment penalties, in the region of three to five per cent will not change the decision.

Tip 3: Secured loans (especially home loans) are a little more complex because they are low cost and may also have certain tax benefits driving their post tax cost down. The decision should normally be taken in consultation with your financial consultant. As a thumb rule (not applicable in all cases) however, it will normally make sense even to prepay the home loans as long as the prepayment charges do not exceed 2%. There are two big exceptions to this thumb rule.

• Where the interest rates on the home loan are lower than the current ruling rate (for example where you had entered into a fixed rate contract earlier).
• If principal repayment of the home loan increases the amount of deduction under section 80C (this will happen if you are not fully utilising the Rs 1,00,000 limit of deduction under this section through other modes of investment such as Life insurance premiums, contribution to provident funds, etc)

Tip 4: Be aware of the prepayment penalties applicable in your case. Often customers are asked to sign loan documents with no mention of prepayment penalty.

Tip 5: Prepayment penalties are not written in stone. They can be negotiable if you have a good credit history. For a select few consumers, banks may sometimes also waive this penalty.

They may be more inclined to ignore or reduce the penalty in situations where interest rates have been climbing after the disbursement of the loan and the loan carries lower than the market rates of interest.

Tip 6: Save on prepayment charges by making partial prepayments. Quite a few banks do not charge prepayment penalty if the loan is prepaid partially. The definition of what constitutes partial prepayment varies from bank to bank.

You can make enough prepayment to ensure that you still need to pay a few more EMIs (normally 12) to completely clear off the loan. This will ensure savings in the prepayment penalty. At the same time, it will help you to save on high interest costs on a substantial portion of the loan.

apnaloan.com is a guide to the best home loans in India.