Should You Prepay Your Home Loan or Make New Investments?

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09 JUNE, 2021

As a home loan borrower, you may often find yourself considering prepayment versus investing in a new financial tool. Over time, as your income increases, you can face confusion regarding which one to opt for. So, how do you decide between reducing your loan burden in comparison to gaining more returns? Find out if it is a good idea to prepay your home loan or make new investments with the step-by-step guide below:

Step 1: Consider your long-term financial position
Before deciding if you should opt for home loan prepayment, you must first assess your long-term financial condition. You may require money to meet several other goals in the future such as your child’s higher education, marriage, parent’s retirement, etc. As the interest rate for home loan is lower when compared to any other loan type, it is crucial to evaluate if you can afford a lump sum payment. If you have enough funds to manage your long-term needs and make a prepayment, then the question of prepayment versus other investments arises.

Step 2: Take home loan tax benefits into account
Now that you have estimated the funds you have, you should consider the tax benefits of a home loan. Though most individuals do not opt for home loans to save taxes, you cannot deny the obvious benefits. Thus, it is advised to consider the deductions available for home loans and the impact of making a partial or full prepayment on your tax liability. You can claim a maximum amount of Rs 1.5 Lakh on the principal component and a deduction of Rs 2 Lakh on the interest pay-outs. If this doesn’t bring down your tax liability much, then you may consider other investment options.

Step 3: Review home loan prepayment charges
Lenders charge you a prepayment fee for making partial or full home loan prepayment. This is because paying a lump sum affects the interest payments and the original tenure of your home loan. However, the charges can vary from one lender to another. Additionally, keep in mind that if you have opted for a floating rate home loan, prepayment charges or penalties cannot be levied.

Step 4: Examine alternative investment options
After understanding the home loan tax benefits and prepayment fees, you must finally decide if an alternative investment will give you enough returns. As home loans have a longer tenure of up to 20 years, you need to evaluate the returns from the investment tool for a similar tenure. It is recommended to choose an investment option that offers lucrative returns in the future. But the gains from both home loan prepayment and a new investment tool should be reviewed after considering the long-term tax benefits.

Home loan prepayment could be an option for many, as borrowers wouldn’t like to have a long-term financial burden. Nevertheless, assessing the benefits of both prepayment and using the extra funds toward another investment can help you choose the right option.

Disclaimer: This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank make no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.

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