Spend it, save it or invest it? We all have been dreaming about that much-awaited Diwali bonus and have probably made plans about how to use it last Diwali itself. But before you go ahead, hear me out.
I won’t stop you from fulfilling your much-awaited dream. However, if you put some portion of the bonus aside, it can prove to be worth much more in the long run. With Diwali being a festival of new beginnings, why not give yourself the gift of a new home? Here are two ways to use your bonus more efficiently:
Pay off your loans
With rising repo rates and the consequent increase in interest rates, you should close any credit due to save on interest payments. It is advisable to first pay off all unsecured loans such as credit cards and any personal loans, if any, since the interest rate on them is higher.
Next, you should look to settle your home loan – fully or partially, based on how much money you can set aside. Though this isn’t the most exciting use of your money, not only will it save you money down the road by way of lower interest payments, it will also bring you that much closer to owning your own home.
Prepayment
Considering that there may be certain pressing requirements where you need to spend a major chunk of your bonus or if you need the current bonus to replenish your emergency funds or liquid cash, there is another option. Prepayment is a very useful tool that helps you get all these benefits, while not impacting your bank balance in a big way.
Let me explain how this works:
A home loan is paid through EMIs, which consist of two parts: principal repayment and interest paid on the principal due. In the beginning of your repayment journey, since you owe the entire principal amount, your EMI has a bigger portion of interest on the loan and a smaller amount paid towards the principal borrowed.
Over time, as you pay the EMIs regularly, the principal due gradually decreases, leading to a reduction in the interest component and a higher amount paid towards the principal due. Eventually, once you repay the entire principal due, the loan is closed.
Prepayment is the amount paid over and above the EMI. Since you have already paid the interest portion due for the month through the EMI, this amount is directly deducted from the principal due.
This leads to a reduction in the interest charged on the principal in the following month since the principal has been repaid earlier than scheduled. By making regular prepayments, you end up paying your home loan earlier than the loan tenure while saving lakhs of rupees in interest payments.
Despite being a win-win feature for borrowers, many are unaware of this or forget to make regular prepayments. Certain lenders now offer an option for regular automated prepayments, which could make a big difference. Under this option, you can give your bank standing instructions to deduct a small amount such as Rs 2,000 from your account every month towards prepayment of your home loan.
Over time, this small amount helps you repay the home loan earlier than the loan tenure, saving lakhs of rupees in interest payments.
Let me clarify this with an example:
Let’s assume you have taken a home loan of Rs 20 lakh for 20 years at 9.5 percent interest rate. Your EMI in this case would be Rs 18,643. Over 20 years you will end up paying Rs 24,74,320 as interest over and above the Rs 20 lakh loan. However, if you make a Rs 2,000 prepayment every month, you will save 55 EMIs and Rs 6,60,585.
So, this year, use your Diwali bonus effectively and gift yourself the joy of celebrating your next Diwali in your own home.
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