Should you prepay your home loan now, after six hikes in policy rate?

Should you prepay home loan

The misery of home loan borrowers is set to worsen after the Reserve Bank of India increased the repo rate yet again by 25 basis points (bps) on February 8. This is the sixth consecutive hike in the policy rate, taking the overall increase to 250 bps since May 2022.

As a result, the equated monthly instalments (EMIs) of borrowers which have already increased significantly, will go up further.

“The rate hike of 25 bps today will make EMIs expensive by approximately 2-4 percent. Borrowers will either have to shell out extra money to repay their loans or will have to extend the tenure,” said V Swaminathan, executive chairman of Andromeda Sales and Apnapaisa.com, a loan distributing platform.

As per Andromeda’s calculations, the EMI for a 20-year home loan of Rs 70 lakh at 7 percent in May 2022 will increase by Rs 10,978 each month to Rs 65,249 per month, considering the present home loan interest rate of 9.5 percent for the same tenure. That’s an increase of 20 percent in the EMI, assuming the loan tenure remains the same.

With many borrowers likely to feel the pinch of such an increase in EMIs, the question is: Does it make sense to prepay the loan?

Financial prudence

Prepaying refers to paying your home loan partly or entirely before its tenure. Part-prepayment helps to reduce the EMI and tenure.

Also Read: What should debt fund investors do as RBI hikes repo rate?

An increase in EMI of such magnitude – more than 20 percent in one year – can impact and jeopardise a borrower’s cashflows. It can lead to less money in hand to manage monthly expenses and other investment commitments.

“Borrowers need to make prepayments as that's the only way to control the cost of your borrowing, given the rapid rise of the interest rates. For a 15-year loan, the EMI per lakh has gone up by Rs 145. If the EMI doesn't go up, then the 180-month tenor spikes to 270 months – that’s almost 7.5 years,” said Adhil Shetty, CEO of BankBazaar.com.

Also Read: RBI raises repo rate as expected, but does not hint at end to hikes

According to Swaminathan, a borrower should first evaluate his or her current financial situation.

“Are you paying your existing home loan EMIs comfortably? Can you manage your financial and emergency requirements along with this EMI? In case you plan to prepay your home loan, you will have to shell out more money. So, it is prudent to prioritise your financial obligations first and then allocate surplus funds in repayment,” added Swaminathan.

Also Read: Increase home loan EMIs or tenure: What should borrowers do?

Liquidating investments

A major problem that most borrowers face is not having significant surplus funds to make a prepayment. In such cases, the only option for most of them is to redeem their investments to generate funds and prepay the loan. But does this make sense?

According to Suresh Sadagopan, founder of Ladder7 Financial Advisories, while home loan interest rates are above 9 percent, they are still much lower than other loans.

“Prepayment can be done subject to availability of funds. It may not make sense to liquidate investments as investments would also correspondingly offer higher returns,” said Sadagopan.

However, Sanjeev Govila, CEO of financial advisory firm Hum Fauji Initiatives, has a different perspective.

“Earning 9 percent consistently on own investments takes a lot of financial astuteness and long-term planning. It is surely not easy unless one is a long-term learned investor in growth assets like equity. So, if your own investments are earning less than this rate after-tax, it makes sense to do at least some part-prepayment of the home loan from such investments,” said Govila.

Whether you should redeem funds from your debt instrument or equity investment, will depend on your asset allocation and cash flow needs, said Lovaii Navalakhi, CEO of financial planning firm International Money Matters.

“After you remove the funds for repayment, the allocation should be as per your risk profile. Also, if liquidity is required for any other goals in the short term, that should be provided for,” he added.

“Do not rush into breaking your investments and making prepayments. Instead, plan towards it. You can do it in different ways, depending on what suits your financial situation best,” advices Shetty. “What is important is that you do it in a planned and structured manner so that your finances are not stretched but you make savings on your loan at the same time.”

Tax factors

Apart from a higher interest rate and availability of funds for prepayment, there are other factors that one should also evaluate.

“One of the most important benefits of having a home loan is the tax deduction benefits you get. You get tax benefits of up to Rs 5 lakh – with a deduction of up to Rs 1.5 lakh on principal repayment under Section 80C and up to Rs 2 lakh on interest payment under Section 24(b). More so, an additional tax deduction of up to Rs 1.5 lakh is available for first-time homebuyers on the home loan interest component under Section 80EEA,” said Swaminathan.

In such a situation, knowing how foreclosure impacts your tax planning requirement is imperative, added Swaminathan.

However, the Budget 2023 proposals indicate that the old tax regime with tax deductions will eventually become redundant and you may not be able to continue claiming deductions forever.

This makes a stronger case to prepay your loans, if you can. And whenever you can. After all, that is one less debt obligation.