If you have a home loan, you may have often thought of
repaying it, either in whole or in parts. What’s the best way to repay?
We receive a lot of queries from young double-income-no-kids
(DINKs) clientele, whose primary and high priority goal is buying that “dream
home”. On an average, one out of five clients asks such a question. They are
usually in the middle of paying a home loan, or have booked an apartment and
want to know which is the best method to fund it—through regular equated
monthly installments (EMIs), or only interest payments for under construction
properties.
What are the tax benefits that they can claim in both
options? Whether the vested stocks they receive annually or the bonus they get
should be directed to reduce their home loan liability? Which is the best EMI
option: fixed or floating? Which option to choose when interest rates are
rising or falling, and what is the fine print on “fixed interest rate”? These
are just some of the questions that we receive on a regular basis.
Obviously there are many permutations and combinations, and
each case is unique and requires individual analysis, calculation and guidance.
The idea is to work out the best possible option for loan repayment, to enable
the lowest impact of interest rate cost to the client.
Firstly, there are many ways to reduce the burden of a home
loan—through prepayment (partial or full), by increasing EMIs, or shifting to
another loan.
Some choose to foreclose an existing loan and take another
loan with the same bank or another bank. This scenario works best in a falling
interest rate regime. Mind you, there are costs associated with this, and every
individual’s loan would involve weighing the pros and cons based on the client
situation at hand.
Some choose to increase their EMIs (from the normal specified
for a given rate of interest and tenor) to reduce the principal outgo, reduce
the tenor, and thereby, reduce the interest charged by the bank. This choice is
possible when other commitments such as child’s education are already being
saved for or the goal has already been met. Some people prepay from the bonus
that they may have received or other windfalls.
Let’s assume a client has taken a home loan a few years ago,
and has a current outstanding amount of Rs.26,04,262 with a monthly EMI of
Rs.36,407 to be repaid to the lender. The current interest rate on this loan is
11.75%, and the remaining tenor is 124 months.
There are four scenarios in which this Home Loan India can be
repaid. The aim is to see which option works in the best interest of the client
for a speedy closure and lowest cost incidence.
Scenario 1: We are assuming that the client makes no change
in her EMI, and continues to make the monthly payment towards her home loan.
The total interest to be paid for the remaining tenor of 124 months would be
Rs.18, 99,000.
Scenario 2: We tweak the interest rate and reduce it to
10.50%, and assume that the client’s affordability hasn’t changed and she is
paying the same EMI of Rs.36,407. Since, the interest rate is reduced, she can
close the loan in 113 months, saving a total interest of Rs.3,94,000 over the
remaining tenor of the loan.
Scenario 3: We further play with the numbers, and assume that
the client will make prepayments towards the home loan from the annual bonus
she receives. With the same EMI of Rs.36, 407 and assuming that the client and
her spouse are able to make annual prepayments of Rs.2, 00,000 for a duration
of five years, the total interest paid under this scenario will be Rs.10,49,147.
And surprisingly, the loan will be completed in just 73 months, versus the
original duration of 124 months. The total interest saved in this option, is a
substantial Rs.8, 49,803.
Scenario 4: Lastly, we worked with the assumption that the
client is able to increase her EMI to Rs.42, 000 per month (because of her
annual pay hike). She will be saving a total interest of Rs.4,76,000 over the
remaining tenor of the loan, and by doing this, the loan would completed in 96
months.
The result
After doing these calculations, we finally went back to the
drawing board and provided the client with the analysis of our findings under
different scenarios.
What we learnt was that maximum amount saved (Rs.8, 49,803)
through interest was with the annual prepayment option. In this scenario, even
the loan tenor came down to 73 months. But this is not a thumb rule. One must
analyze factors such as the outstanding loan amount or the bank’s prepayment
charges asked by banks. Apart from this, some banks also put a limit on the quantum
of prepayment allowed in a year. Such clauses must be studied carefully. Then
there are the client’s other goals to be seen—life insurance, healthcare,
retirement planning, or even tax planning.
[Source: http://www.livemint.com/Money/DqhQ6uOxGDtpKyfEMElWwK/How-best-to-reduce-the-burden-of-home-loan-prepayment.html]
