When you take a home loan, you agree to repay it over a specific tenure. However, you may want to repay your loan before the term expires. So how to do that? The borrower can refinance the loan with another bank offering a lower interest rate. In this case, the person pays off the existing loan in full and gets a new loan at a reduced interest rate.
Another reason to foreclose a loan is to save on paying interest. For example, a borrower may have surplus funds and want to close the loan earlier to save on interest.
Home Loan Foreclosure Charges:
Banks do not want you to repay your home loan earlier because it means losing on their interest income. Hence, you may be asked to pay a prepayment penalty of a certain per cent of the outstanding amount. It could act as a deterrent to foreclosing a home loan.
However, RBI has clarified several times that banks cannot charge you a prepayment penalty when you foreclose a home loan if your loan is at a floating interest rate. "To help home loan buyers prepay the loan, RBI has waived off the prepayment charges in case of floating interest rate and have kept the penalty up to three per cent in case of a fixed interest rate. Earlier, the lenders were asking for a prepayment penalty of up to five per cent of the loan amount," says Anant Ladha, founder, Invest Aaj For Kal, a financial advisory firm.
Also, he said if you prepay the loan after six months, you can prepay up to 25 per cent. "For prepaying the principal amount above 25 per cent, you will have to pay a prepayment fee of two per cent in some cases," adds Ladha.
Other Things To Consider:
There are other things one must consider before prepaying for a home loan. For example, you get a deduction of up to Rs 2 lakh on interest payments under section 24(b) of the Income Tax Act. For those in the 20 per cent and 30 per cent tax brackets, it can help save Rs 40,000 and Rs 60,000, respectively.
In case you prepay your home loan, you will not be eligible to receive this benefit. Also, there is a deduction of up to Rs 1.5 lakh under section 80C. However, since most of this limit is exhausted in mandatory contributions to employees' provident fund (EPF), insurance premiums, public provident fund (PPF), etc., most people cannot claim a deduction on principal repayment.
Also, remember that a home loan is a secured loan with a lower interest rate. So if you have other outstanding high-interest-rate loans like credit card debt or personal loans, it makes sense to pay off the high-interest-rate loan first.
However, in times such as these, when the interest rates have gone up and the interest component of the loan is higher than Rs 2 lakh, it may make sense to prepay a part of the home loan as the interest payment would come to Rs 2 lakh and it will be optimal in terms of tax savings.
Also, it makes more sense to prepay a home loan in the early years of the loan rather than in the later years, as this would help you save the maximum interest.
Hence, consider all the pros and cons when repaying a home loan. However, if you have a floating-rate loan, you need not be worried about paying a prepayment penalty.