Home Loan Prepayment – in the Part-1 of this blog, we looked at the structure of EMI. We will in this Part-2 of a blog look at the Pros vs Cons of the prepayment. Then we will also look at scenarios under which it is not very wise to prepay.
Pros of Home Loan Prepayment
No monthly outflow of cash
First step towards financial independence is to generate positive cashflows each month. One way to do that is also to reduce all cash outflows. This allows us to invest saved cash outflow.
Peace of Mind
“Take a home loan to love your work. Take two home loans to love your boss also along with your work” – an internet joke which is so true 🙂 The peace of mind having no financial commitment is something most of us yearn for
Flexibility to plan your finances
Lesser cash outflow does mean that you have the power to choose what to do with that money. You can invest or spend!
and the Cons
Expensing the savings than investing
The EMI which we dont have to pay should be used for investments. What I realised is that I am expensing the savings (by increasing my lifestyle) rather than investing them for bigger purposes.
Possible loss of overall discipline
A loan to be repaid, brings overall financial discipline to the family. Control over expenses, clear idea on what to invest etc. One big disadvantage is that there is a chance, we will lose this discipline.
Increased tax expenses
Home loans do provide tax benefits for both interests and the capital that is repaid. So prepayment of home loans do lead to more tax expenses.
So what does the math say?
Effective interest rate
Because of the tax savings, the effective interest rate you pay is lesser. For a 40L 20 year loan paying 7.57% interest, my effective Loan rate is 6.07% (assuming I am in the 30% tax bracket)
Clearly there are also some points to be considered before prepaying the home loan. I would not prepay a home loan under the below situations.
Have no emergency fund
We should never pay off home loans by breaking the emergency fund.
A big expense is coming my way
We tend to get emotional and pay off home loans. And next year we have a big expense coming our way and we end up using Credit card or personal loans for the same. This is bad planning!
No control or plan of investment
If a person is a spendthrift by nature, create a plan before jumping to pay off loan.
While the maths does say that effective interest rate is lesser. The market trend says it is easier to invest in assets which return more than the effective home loan rate. Also there are many pros to prepayment of the home loan.
To conclude, the best way to go about home loans is to do small prepayments periodically. It would be lovely if we can generate this prepayment amount as returns from our investments. My personal recommendation based on experience is to prepay home loans every quarter without touching my Emergency fund or reducing my monthly investments. Good luck 🙂
well written Gopal, i believe it will be a good idea to have that template as well which will help people (who need data to trigger their thoughts)
Thank you Partha, sure. I will add that template in the tools section soon.