interest rates are rising, but don't rush to pre-pay your
home loan, says Sanjay Matai.
days, it seems, are gone; from the borrower's perspective
at least. The days of falling interest rates seem to have
come to an end, at least for the time being. While interest
rates fell sharply from around 2001-02 onwards, we have
seen them hardening in the last year or so.
the fall was very sharp and, comparatively, the rise has
been reasonably modest; interest rates are still quite
affordable. Moreover, there has been an appreciable rise
in average income levels in last two years.
with interest rates rising (some more hikes are expected
going forward) some borrowers are contemplating prepaying
if not in full, at least a part of their
outstanding home loan amounts. The funds required for
this could come from bonuses, profits in the stock market,
maturity or liquidation of some old investments, etc.
everyone would like to be debt-free. And a 10 to 15-year
period of indebtedness clubbed with the uncertainties
of job and life is, obviously, makes for an uneasy situation.
From a purely psychological perspective, therefore, one
may be better off paying one's debts.
would you gain or lose by doing so? An example should
help us look at the financial perspective.
Say a person took a home of loan of Rs10 lakh two years
ago at a floating rate of 7.25 per cent, with a tenure
of 10 years. Accordingly, the EMI payable was Rs11,750.
The borrower has so far paid 24 EMIs out of the total
bank has now raised the interest rate to 8 per cent. This
means the remaining 96 EMIs would now be at Rs12,072.
Alternatively, the borrower could ask the bank to extend
the loan period to prevent the EMIs from increasing. To
cover the increase in interest the EMIs will increase
from 96 to 100. This means that while the rate increase
from 7.25 per cent to 8 per cent may appear steep, the
actual increase in EMI is merely Rs322 or four additional
EMIs. These are not really significant, and one need not
worry too much about small interest rate hikes.
let us look at the financial implications from another
perspective. This exercise would also be useful if you
have the money and can repay, to determine whether to
continue with the loan or not.
paying 24 EMIs, the loan now outstanding is Rs8.53 lakh.
The total EMIs amount payable is Rs11.7 lakh. This means
the interest component works out to Rs3.17 lakh. Let us
say the bank would charge 2 per cent as prepayment fee.
Should you pre-pay the loan?
the loan is prepaid, the person would have to pay the
bank the loan amount of Rs8.53 lakh and a 2 per cent pre-payment
penalty of Rs17,061 a total of Rs8.7 lakh. But
if you decide to continue with the loan, then apart from
the loan amount you would have to pay interest of Rs3.17
us not forget, however, that you would save income tax
of Rs95,112 (30 per cent of the interest repayable on
Rs3.17 lakh) as the interest on home loans can be deducted
from your taxable income. Calculating this, the net interest
outgo is only Rs2.22 lakh.
from tax, there would also be an interest earning on the
available funds of around Rs8.53 lakh, if that amount
were to be invested instead. Even if this amount were
invested in a 100 per cent safe instrument like NSC, you
would earn a post-tax return of Rs3.82 lakh over eight
years. Altogether, therefore, the total cash outflow works
out to only Rs6.93 lakh. This is Rs1.77 lakh less than
if you were to prepay your loan.
shows that even when investing in a safe option, the borrower
is better off continuing with the loan. If you invest
a part of this amount say 20 to 25 per cent
in equity, you could earn even better returns over the
eight years of loan repayment.
it is important to analyse the various options available
and take an informed decision, instead of being unduly
alarmed by small increases in home loan rates.