Home Loans are usually a big burden, not only financially but mentally too. Home loan rates keep changing with time and economic scenario (they may go up or come down); yet regardless of the changes that may take place a home loan continues to hang over as stress factor over the borrower’s head as generally, the borrowed amount is huge.
Thus if one were presented with an option of pre-paying in case they have spare funds available, then it would seem like a good option but is it so in all conditions? If the borrower has spare funds available then is foreclosing the loan the best thing to do? There cannot be a blanket yes or no.
Whether one should foreclose a loan or not will depend on a lot of factors; some of them we discuss here.
Though interest is a huge burden for the borrower one cannot overlook the tax benefits one can enjoy on the loan repayment. Loan repayments are eligible for deductions under various Sections of the IT Act. A
A home loan borrower can claim relief under Section 24(b) up till Rs. 200,000 on the interest repaid on his/her loan for self-occupied and even for rented houses. The benefit is also available under Section 80C, the limit being Rs. 150,000; this is available on the principal repayment.
Foreclosing the loan can make you lose all these benefits so you need to weigh in that factor. The tax benefits one enjoys helps in reducing the effective interest cost of the loan.
Consider Prepaying Other Loans:
It is likely that the borrower does not have only a home loan so if you have spare funds you could consider repaying other loans too. Personal loans are usually available at much higher rates than home loans and there is no tax benefit also available on them so these are much more expensive when compared to home loans.
Similarly, education loan interest rates are also higher than home loan rates but these loans also enjoy some tax relief. Auto loans are generally at lower rates and offer no tax benefits whatsoever.
So before repaying a home loan consider the actual cost of your other loans (if any) and then repay the home loan. Paying other might be easier as usually their ticket size will not be as big and these loans could prove to be generally more expensive than the home loan.
Leave Something for Emergencies:
Being loan free could offer you a big mental relief but it should not be paid at the cost of exhausting all your savings and using them to repay a loan. One must definitely leave aside something for contingencies. (Read: Keeping emergency fund – first step in Financial Planning)
While you own house offers a lot of security, having some liquidity at all times is a must. A house will not offer immediate recourse to funds if the need arises. A borrower can take the right amount and kind of insurance to keep his loved ones secure in the eventuality of a mishap.
Dipping into your savings and exhausting them for foreclosing a loan is not good. If you have sufficient surplus that does not compromise your liquidity then only consider foreclosure of a loan.
Interest Paid V/S Interest Earned:
One would consider repaying a loan only if they have spare funds and if they do not use these spare funds to repay this loan or any other then this amount would be invested to earn returns.
The post-tax interest cost must be compared with the post tax returns that would be generated on the investment. Fixed deposit interest rates these days are generally around 6.5% to 7%, to calculate the actual returns one must consider the tax that would be deducted on the interest earned as per the tax bracket.
If one is looking at other investment options like bonds, equity, mutual funds then one must compare the post-tax returns of these too with the cost. Thus if you feel that the investment that you make will generate lesser returns than what you could save by prepaying then you should opt for foreclosing a loan.
To Sum it Up………..
Foreclosing a loan makes sense in the following scenario:
- If the total interest that you pay is more than the tax benefits that you can get.
- If you have surplus funds and feel you will save more by paying the entire loan rather than investing it.
- If you want to reduce your debt to income ratio.
- If there are no other expensive debts that you can consider repaying.
- If paying of the loans will not compromise your liquidity situation or drain your emergency fund.
This is a guest post by team credit sudhar
Image courtesy : unsplash/dane–deaner