Ravi Chandran
Most of us are averse to being debt ridden, but housing loan early redemption may not be always the best decision
A loan, of any type, is a debt that one would typically want to repay at the earliest (preferably prepay i.e. pay before it’s due). However, a home loan should not be considered in the same light as a personal loan, car loan, etc. A home loan offers a number of benefits which may make prepayment unbeneficial.
Housing loan early redemption, or what some call prepayment is a facility which allows you to repay your housing loan (in part or full) before the completion of your loan tenure.
Usually, customers opt for prepayment when they have surplus funds. But you have to think again before you do housing loan early redemption and consider important factors before deciding to prepay your housing loan.
FUNDING NEEDS
Before considering prepayment of your housing loan, you need to ensure that you have sufficient funds for your financial goals such as marriage, travel abroad, etc. You should avoid being in a situation where you have overextended yourself to prepay your home loan and, as a result, are funds-strapped when you need to meet a financial goal. Moreover, you also need to ensure that you have surplus funds available for medical emergencies, or unforeseen events such as job loss.
INCOME FROM INVESTMENTS
The cost of prepayment should also be compared with the returns that can be earned from investments. If you have the opportunity to earn returns which are higher than the home loan interest, then it is better to invest the surplus funds rather than using the same to prepay your home loan.
A home loan is a long duration loan; in order to make an ‘apples-to-apples’ comparison of your home loan cost vis-à-vis a comparable investment, equity investment should be considered. Equity investment is a long term investment where the risk reduces in proportion to the period of investment, i.e. the longer you hold your equity investment, the lower will be the risk.
Very often investing the surplus funds is more fruitful than housing loan early redemption.
STAGE OF THE LOAN
The main benefit of prepayment is the reduction in interest outflow. The interest component is highest during the initial stage of the home loan. Therefore, prepayment of loans in the mid-to-late stage may not give you the full benefit of saving on interest. In such cases, it is prudent to invest the surplus funds.
INTEREST RATE
Housing loans are easier to service – the interest rate on home loans is generally lower than the rate of interest charged on other loans such as personal loan or credit card loan. Therefore, if you want to reduce debt, it is better to prepay high interest-bearing loans on priority basis (as against housing loans which carry a lower rate of interest).
PENALTIES FOR EARLY REDEMPTION
The reason why most home owners do not prepay their housing loans is because of the penalties imposed by the lenders for prepayment. Always check your loan contract to ensure that you are not paying unnecessarily to fully redeem a loan, when you can save money by letting that money just sit in your savings account.
Mr Paul Ho, chief officer at iCompareLoan, said, “it is always good to check with a loan specialist if your housing loan early redemption is worth it. They can give you the best advise.”
