Home Loans are huge debts. Housing finance lets you realise the dream of your own home, but Home Loan repayments form a large percentage of your monthly expenses. This brings us to the question: when you get a good chunk of spare funds, should you use it to reduce this debt, or look for an investment option to let the funds grow?
The answer depends on your situation and your own viewpoints. Still, there are some points you’ll need to consider while making a decision.
A Case for Investment of the Funds
In certain situations, you might be better off continuing with your Home Loan EMI and directing the spare funds towards other avenues.
Your Age and Earning Potential
If you are young and earning an income that lets you keep up easily with your EMIs, you can consider investing in high-growth-yet-risky options like mutual funds. Even in this scenario, paying off a part of your debt can help you bring down your monthly expenses, freeing up spare cash for other purposes.
When you take a home loan for your new home, it also provides you tax benefits on both the principal and interest. While considering prepaying the loan, you can consider the amount of money you save through tax benefits against what you would save by prepaying the loan.
If you would save more in terms of tax benefits, you can consider putting off prepaying the loan, and investing the funds instead.
Other Vital Needs, like Investing in Children’s Education Funds
Home Loan repayment usually takes up to 30% of your salary, and you might want to invest in secure growth funds for other needs like your child’s education, or in pension funds for your post-retirement years.
If you are sure that you will be able to keep up with the EMIs easily for a few more years, consider investing for long-term needs when you have a large amount of cash at hand.
Investing in Instruments that can be Easily Liquidated
Let’s say you’ve invested all your spare funds in long-term options, and need to make some investments for shorter periods, where you could easily get access to the amount in case a pressing need for funds comes up.
You can also check monthly EMI with the help of home loan calculator that will show you whether EMI is bigger or not; in this case, if the EMI on the Home Loan is not that big a burden for you, simply divert the extra funds towards some short-term investments that can be easily liquidated.
Other Loans that Need to be Repaid
If you’ve taken a Personal Loan or other unsecured loan, consider paying these off first. These loans do not provide any tax benefits, and come at a higher rate of interest. Getting rid of these debts first makes sense; you will also be reducing your liabilities when you pay off these loans.
A case for Home Loan prepayment
If you feel that the Home Loan payments are dragging you down and you would like to get out of this debt quickly, consider prepayment of the loan.
Getting Rid of Debts is a Priority for You
You should always prefer paying off your loans and other debts. The Home Loan is an unavoidable debt for those who want to purchase their own homes. Housing finance lets you buy your dream home, but repayment can drag on for years, and you might prefer paying it off quickly, before you approach retirement age.
The Home Loan EMI is a Huge Part of your Monthly Expense
If repayments are dragging you down, you should consider prepayment of the loan. Look for penalty clauses in your Home Loan on prepayment. Many banks allow the borrower to make a specific number of partial prepayments on their loan without charging a penalty.
You can then make part prepayments within the allowed limits, thus bringing down the overall debt burden. By prepaying the loan, you either reduce your monthly EMI, or the loan tenure.
You Save More through Prepayment
Say you’ve been making EMI payments on the loan for some years now, but the payments have not yet significantly brought down your Home Loan debt.
This is because, in the initial years, most of your EMI goes towards the interest component rather than the principal amount. You feel that the tax benefits will provide you less savings than what you could save on the interest charges by making prepayments.
In that case, use the spare funds to prepay your Home Loan.
Which Option Should you Choose, then?
If the EMI is too heavy an outlay for you, you can choose to reduce that by making a prepayment. By default though, it is the tenure of the loan that is reduced when you make prepayments. This makes more sense as it also brings down the overall interest you pay on the loan, thus saving you a huge chunk of money.
So, whether you receive a one off influx of funds or you have just had an increase in salary, try to tweak your EMI, paying off more each month to bring down the number of years you have to pay off the loan.
A Home Loan is an expensive proposition, and results in a heavy debt component for most people. Apart from the loan amount itself, it also includes the processing charges for Home Loan, penalty clauses for late payment of EMI, penalty for prepayment, and other such charges.
The interest charged on the loan adds to the burden and your initial payments goes towards the payment of the interest amount rather than clearing the principal borrowed.
Though the live-on-credit idea is catching on in India, the general tendency is still to get rid of debts as soon as possible. In most cases, it makes more sense to direct spare funds towards reducing debts rather than investing in risky growth funds. Depending on your stage of life, your financial position and other priorities, choose carefully.