Home loan is one debt that is often very high in value. Payment of EMI takes years to complete. Important question is should you pay home loan early? As home loans are big in amount, their monthly EMI is large. Every month EMI digs big hole in ones wallet. Ask a persona who pays regular EMI’s for home loan. One understanding will be common, they will all dearly like to finish home loan.
This is particularly true for those people who have taken home loan at high interest rates. In India, present home loan interest rate is in ~10.1% per annum. Lets look at some points which will guide us to decide whether should you pay home loan early or not.
It must be clearly understood that loan costs us money. It may make our life easy for a moment but in long term its a big expense.
Point No.1 – Pay home loan early & Save money
If one has availed home loan at interest rate as high as 10-11% per annum, then he/she shall pay this home loan early. These days even equity returns are not reliable even in long term. So a home loan bearer, instead of investing, shall try to save 10%-11% interest.
Saving on interest can also be considered as equivalent to investing. Because you are generating savings from no where. Anyways, whatever reason you give to yourself, but one must pay home loan early. This will save lots of money for you in form of interest payment.
Having a house is important and in a way a necessity. Even if you are not living in that house, but the way the real estate price are increasing it is better to buy today then wait for tomorrow. On positive side, in real estate the money multiples faster than any other form of investment.
It is also a fact that home loans saves us income tax. But this income tax saving is not so big. I will give you a comparative figure. Suppose you are paying an EMI of Rs 30,000/month. Then on account of this home loan your income tax saving per month will be about Rs 1,000. So, we cannot go on carrying home loan just because it saves us inocme tax. Yes, I have heard people saying that because it saves income tax so lets keep it alive. To such people I often give the above comparaitive example between EMI and income tax saving. Its important to pay home loan early.
Point No. 2 – Large emergency fund?
Should I start extra payment with objective of paying home loan early from day one? Yes, the burden of home loan interest is so huge that, if there is a chance one shall start making extra payments from day one. But home loan rule does not give is that flexibility.
In AXIS BANK one can prepay home loan, but prepayment amount shall be equal to one EMI. Not may will have ability to pay each month one EMI plus additional EMI for prepayment. Means each month the payment will be 2 x EMI. Moreover, one shall also look at their emergency fund. Early payment of home loan is important but more important is financial security of ones family. If your emergency fund already has 6 months worth of expense, then you can think of using your extra savings to pay home loan early. Suppose ones monthly expense is Rs 50K. If he has Rs 50,000 x 6 = Rs 300,000 in savings allocated for only emergency fund (excluding other savings) then he shall start prepayment of home loan.
Point No. 3 – Pre pay your costlier debt before your home loan
Home loan is always a cheaper-debt than personal loans (auto loans etc). If one is also carrying personal loan (interest @ 14% per annum) then it is advisable to pay this loan first. Extra savings shall be used to pay back personal loan before home loan. Home loans are always a cheaper debt than personal. We shall try to costlier debt first. Like credit card debt is the costliest debt of all. Needless to say that it must be paid first thing every month.
Point No. 4 – In rush to pay home loan early, one shall not compromise retirement linked savings
I know you will be surprised to hear this but it is a fact. Retirement savings has several levels of advantages. But the most important is that requirement of money after retirement. In that age and time we are extremely dependent on money to manage even small requirements of life. So nothing can be more important for us than to go on contributing maximum towards retirement savings.
Additionally we also get a huge income tax benefit in retirement savings scheme. Income deduction to tune of Rs 100,000 is allowed by Indian government. If has not touched the Rs 100,000 mark, better will be to increase contribution this value is reached. Provident fund is the most profitable investment that you will come across in your life. Suppose your contribution to provided fund scheme is Rs 10,000 per month, your company will also contribute @12% of your basic salary in your provident fund account (say Rs 8,000/month). So every month your monthly saving is Rs 10,000+8,000. The contribution of company towards your retirement savings (provident fund) is like a free gift. Your self contributions plus companies contribution go on cumulating at the rate of 8% per annum for years to come. Not only it saves you income tax but it also works as automatic saving plan for you.
Point No. 5 – If you are a defensive investor then pay home loan early. This will give you better returns
There are person in this world who do not want big exposure in stocks and equity linked mutual funds. These investment options are too volatile and they do not have appetite for such volatility. In short, stocks and equity linked schemes are very risky.
Defensive investors would instead invest in banks fixed deposits, post office schemes, debt linked funds etc. Such debt linked investment options are all taxable. Post tax returns of debt linked plans are below 6%-7% per annum. Compare this with home loan interest rate of ~10.5%. By comparing debt return of 6-7% and interest savings of 10.5%, it is evident that one shall pay home loan early. Invest your extra funds in prepayment of home loan instead of investing in debt schemes. This way you will finish your loan early. Once one home loan is finished, you can simultaneously plan your next property. This is a fantastic way of creating long term wealth.
Point No. 6 – If one is nearing retirement, the situation may be different
For a person nearing retirement, he will be probably in the last stages of home loan payment. In this tenure, the interest portions of the home loan is bare minimum. Hence starting prepayment at this stage will not effect even reasonable savings of interest.
So if one is not too worried EMI obligation after retirement, I will suggest not to make prepayments. But in case on would like to retire absolutely free of any worries, in this situation one can pay home loan early. Suppose one has 3 years more for retirement. He/She can decide to prepay all balance home loan amount now. This way they will not be required to pay EMI for next 3 years. Same value equal to their EMI, they can start a recurring deposit savings account. This will further accumulate saving, that will be helpful for them after retirement.
If you are nearing retirement one can prepay home loan for emotional comfort only. In early part of ones life, when balance interest is considerable, starting prepayment is best. One can think to pay home loan early if he/she is making extra savings. In case interest rate of home loan if very high, one shall force themselves to start home loan prepayment. If one is a defensive investors who does not like equity investing, then the option of early payment of your home loan is ideal.