The two consecutive hikes of 25 basis points in the repo rate by the Monetary Policy Committee (MPC) seems to have confirmed the reversal of the interest rate regime. Markets are expecting at least one more 25 bps hike this fiscal. Just like other floating rate borrowers, existing home loan borrowers too may have to manage the burden of rising EMIs, and one of the options that they can explore is to make part-prepayments in lump sum. This can help reduce total interest cost without incurring penalty, as long as the loans are on floating rates. However, there are some factors to take care of before making a prepayments.
Here are some tips and suggestions on part-payments for deriving optimum value out of them.
Factor your liquidity while choosing between EMI and tenure reduction:
Home loan borrowers have two options to choose from while part-prepaying their home loans. Either they can reduce their EMIs or bring down their home loan tenure. Although the latter option would result in greater savings in interest payout, the decision to choose between the two should primarily depend on your disposable income. For example, assume that you availed a home loan of Rs 30 lakh about 5 years ago at 10 percent per annum for a tenure of 25 years and the current outstanding is Rs 28.25 lakh. If you make a lumpsum prepayment of Rs 3 lakh at the end of the fifth year and opt for a tenure reduction, you will save Rs 13.88 lakh in interest payment and your tenure will reduce by 5 years and a month. However, if you opt to continue with the same tenure, then your EMI will fall from Rs 27,261 to Rs 24,365, a total interest savings of Rs 6.96 lakh. Opt for the EMI reduction option if the rising interest rate regime threatens to impact your disposable income.
Compare with savings generated through loan transfer
While prepaying your home loans can certainly reduce your net interest cost, doing so by redeeming your existing investments can adversely impact your financial health. If you opt for a home loan balance transfer (HLBT), your existing home loan will be taken over by another lender at a lower interest rate. This will reduce your interest payout without affecting your liquidity and existing investments. Taking the above-mentioned example again, if you transfer your home loan to another lender at say 9 percent per year for the remaining tenure of 20 years, you will still manage to save around Rs 4.68 lakh in interest cost without sacrificing your liquidity and existing investments. Compare the savings derived from part prepayments with those achieved through HLBT and make decision on the basis of your liquidity and financial goals.
Never touch your emergency fund
This fund is primarily maintained to deal with financial exigencies or to meet mandatory expenses during unemployment or loss of income arising out of disability. The size of this fund should be large enough to meet your mandatory expenses for at least six months. If you utilise your emergency fund for making home loan prepayments, any unforeseen event thereafter might force you to avail loans at high interest rates or redeem your other existing investments at sub-optimal prices. Thus, never count your emergency fund while garnering resources for making home loan prepayments.
Don’t redeem your investments earmarked for financial goals
Your financial goals are the monetary expression of your life goals. Some of the most common examples would be creating a corpus for your child’s higher education or arranging down payment for your car loan, loan against property, etc. Redeeming your existing investments meant for those goals may force you to avail costly loans later on. Moreover, many loans require a certain amount to be contributed by you as margin money or down payment. Redeeming the investments set aside for making such down payments or paying margin money might deprive you from availing those loans.
Consider returns generated from existing investments
Although home loans have the lowest interest rates among all retail lending products, their rates are usually higher than most fixed income rates. Thus, a surplus parked in fixed income products like fixed deposits, bonds, etc that is not earmarked for any financial goals can be used to prepay the loan. When it comes to equity investments, their returns usually beat home loans interest rates by a wide margin over the long term. Let’s consider the above example where a prepayment of Rs 3 lakh led to an interest savings of Rs 13.88 lakh in the case of a reduced loan tenure and Rs 6.96 lakh in case of reduced EMI option. If you instead invest that Rs 3 lakh in equity mutual funds generating an annualised return of 15 percent for 15 years, it would grow to Rs 24.41 lakh at the end of the period, generating a profit of Rs 21.41 lakh.[“Source-moneycontrol”]