The boon of part-prepayment of housing loan
By Natraj Muthukrishnan on 6 November, 2009, 11:48 am
We spoke here about the benefits of a joint housing loan. Continuing the same trend here is another tip for the people reeling under the burden of housing loan. The benefits of part-prepayment of the loan.
All of us dream of a home of our own and owning a home in a city without housing loan is a dream next to impossible. Hence, housing loan is something which is inevitable. Now, the trick here lies in getting out the maximum benefits or let me term it this way, suffer minimum losses from the housing loans. The interest rates, especially for the ones with floating rate keep varying and it is always higher than the rate at which you were lured into the loan. In such scenarios, if you have a saving every quarter which you are not sure on where to invest, or you get your annual bonus which you want to put to a good investment, I would suggest part-prepayment of your housing loan is a good option. The reasons, here are they:
- The amount which you pay gets reduced from your principal and lesser the principal lesser the interest.
- You have the option of reducing your loan tenure in case of part-prepayment ( or you can reduce your monthly EMI amount), in case you chose the former, again lesser the loan tenure, the lesser interest you pay. The peace of mind you get by getting rid of the burden earlier is another benefit!
- The amount you end up paying as part-prepayment ends up being added into the 1 lakh savings which you are allowed to be exempted from income tax. A benefit which a fixed deposit won’t earn you.
- Also, going by the current trends a fixed deposit gets you interest in the rage of 8 to 9% while on an average a housing loan interest is of the range 9-10%. So, unless you have some anticipation of some big expense coming your way, it is beneficial to pay out your loan.
But there are certain points to be considered before going for part-prepayment. Each bank has its own guidelines of the amount of money you can do a part payment. For instance, in case of LIC, you can pay 10% of your total loan amount as a part payment in a year in as many installments as you want. Any payment above that would invite penalty charges again which depends on banks. So, before going ahead with part-prepayment do a calculation of the above and decide on which is the best option for you.
I liked the peace of mind got by getting rid of the loan soon. But, I have another view on that : Housing loan interest is exempted from income tax. So you are saving 30% of the interest (given your interest is less than 1.5 lakhs). So if the interest rate is 9-10%, and you are saving 30%, your effective ROI is 6-7%. And investing somewhere else will surely give you more interest than this.
@Poonam,The part-prepaypment amount is actually deducted from the principal. The ROI of part-prepayment is equal to the loan interest rate . I don’t get you how you say the ROI is 6-7%.
I am not debating on the part-payment being reduced from principal part. That is true.
Let me make it more clear:
Suppose you are making a part-payment of 50K.
What are you gaining by this?
The interest that you would pay on this 50K for abt 15 yrs (tenure)@ 9% (ROI).
What are you loosing?
The tax savings of 30% that you would get, had you continued to pay the interest.
So gain is 9% – (30% of 9% ) = ~6%
But if you make the same investment of 50K in some other instrument, (PPF, FD, MFs) for 15 yrs, you will earn at least 9% per annum (may be more if you invest in MFs or stocks).