Most households have multiple EMIs running at a time—from a home loan to auto loan to perhaps a consumer durable loan or even a credit card or personal loan. It is advisable to take loans in keeping with your cash flow and other expenses, there are times when the situation can get overwhelming, especially if there is a job loss or salary cut situation.
If you find yourself with multiple loans and are unable to manage them all, it may make sense to settle some of the loans to reduce the burden, both financial and emotional.
Usually, the home loan is the largest one as it is taken for a high-ticket asset but settling the home loan first to reduce your burden may not be the right approach. Read on to know why.
Typically, home loans have the lowest cost or interest rate attached. It is better to settle the loans that have the highest cost. These are usually credit card and personal loans. The interest rates for these loans can go up to as high as 20 per cent. In comparison, some financial institutions have home loan rates that are as low as around 7 per cent for certain categories of borrowers.
Look at reducing the interest cost burden because that is something that you pay over and above the principal amount. It is better to close the personal or credit card loan first as it is likely to have the highest interest. The next in line should be auto loans. The interest rates for auto loans are usually fixed and are higher than home loan rates. Currently, they are around 7-8 per cent.
“An auto loan is for a depreciating asset (i.e. a vehicle), so it should be repaid second to a personal loan as the interest rates are higher compared to a home loan,” says V. Swaminathan, CEO, Andromeda and Apnapaisa, a loan distribution firm and its digital arm, respectively.
Unlike a personal, credit card or auto loan, repayment of home loans provide a tax benefit on both the interest and principal repayment.
Considering the tax benefits, home loans should be paid off after servicing all other loans. “When it comes to home loans, there are advantages like tax benefits for both principal and interest payment, which proves to be beneficial in the longer term as a house or a home is an appreciating asset and, hence, you can try and keep them for a while,” says Swaminathan.
The principal portion of the EMI paid for the year is allowed as a deduction under Section 80C of the Income-tax Act up to Rs 1.5 lakh. Remember that this deduction is available if the property is not sold within five years of possession. For the interest part of the EMI, a maximum deduction of Rs 2 lakh is allowed under Section 24B. In this case, the loan must be taken for the purchase/construction of a house, and the construction must be completed within five years from the end of the financial year in which the loan was taken.
There could be another deduction of Rs 50,000 for the interest part, under section 80EE, where the amount of loan taken should be Rs 35 lakh or less and the property's value should not exceed Rs 50 lakh. Moreover, there could be a deduction of Rs 1.5 lakh for the interest part, under Section 80EEA, where the stamp value of the property is Rs 45 lakh or less.
Remember that a home loan helps you build an asset for yourself, which is not the case with other loans. A consumer loan or auto loan will also help you acquire and own an asset, but these assets depreciate in value over time, unlike a house.
There is no better feeling of accomplishment like that of prepayment or foreclosure of a loan. “While doing so, one should keep in mind that there are additional pre-payment charges applicable in case of a personal or auto loan; home loans are mostly free of those charges. After paying the entire closure amount, do not forget to obtain the ‘No Objection Certificate’ (NOC) from the lender and the closure shall duly be updated on the credit authority database. Do not forget to ask and collect your original/pledged documents and the removal of lien from the pledged property or the vehicle,” adds Swaminathan.
