It is an interesting irony with Home Loans. Till the time a
person does not have a home loan, he aspires to take one as soon as possible in
order to purchase a home. Once he has taken a home loan, the first priority in
his life becomes to repay his home loan even though it may come with a cost of
his reduced standard of living. It is a prudent decision to repay a loan if one
does not require it. After all why should you pay interest on a loan costing
roughly 10% when you have idle funds sitting in your bank account earning just
4% interest?
However there are a group of thinkers who do not believe in
the philosophy of repaying back their home loans. Let’s discuss the pros and
cons of repaying a home loan and I will leave it to the readers to decide which
the best option suitable for them is.
1. Reduction of Interest Payouts – The most obvious benefit
out of prepayment is that your interest payout reduces. Prepayment of home loan
results in an immediate reduction of the outstanding principal on the home loan
which results in less Housing
Loan Interest Rates being accrued on the loan account. For example, if you
have an outstanding loan of Rs. 10 lacs at 10% interest, you would be annually
paying approx. Rs. 1 lac interest. If you prepay the loan by Rs. 1lac,
your
interest would reduce from Rs. 1 lac to Rs. 90K per year – approx 10 K saving
per year for the duration of the loan.
2. Prepay – without reducing the tenure – Generally when you
are going to prepay your home loan, you have two options. Either you can reduce
the number of home loan installments or keep the number of installments same
but reduce the monthly mortgage payments (EMIs). For example, if you prepay
your home loan by Rs. 100,000, you may be provided two options:
a) Instead of paying your monthly EMI (e.g. Rs. 10K per month
) for original tenure of 120 months, reduce the tenure of the same monthly EMI
of Rs. 10K to 110 months (illustrative) OR
3. Impact on Leverage
This is an interesting topic and in order to understand it
let me take an example. John has an investment opportunity which requires Rs. 1
lac investment and it would provide him annually 15% return. His annual return
in this case is Rs. 15,000.
Now let’s bring in another situation, say John has just Rs.
20K in his pocket and he still has the same investment opportunity. John goes
to a bank and takes a loan of Rs. 80K at 10% interest.
[Source: http://insight.banyanfa.com/home-loan-prepayment/#]
No comments:
Post a Comment