If you have taken out a home loan in the past one or two years, the rise in interest rates has likely impacted you. In this scenario, you might be looking to save some of your hard-earned money. You may be planning to invest these savings or use them for a purchase.
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You might also be contemplating the prepayment of your home loan due to the large EMI payments. If that’s the case, it’s important to consider several factors before making this decision. When you take a home loan, it is systematised in such a way that the interest component in the EMI is larger during the initial years of the loan.
With time, it gradually reduces. That means the interest portion gets reduced. So ideally, the sooner you prepay the loan, the better it will be. This way, there is a bigger impact on the total interest cost as the money prepaid by you goes directly towards reducing the principal amount of the home loan.
Balwant Jain, an expert in tax and investment matters, advised in an interview that if you use a large sum to repay your home loan in full, you should be aware that in the event of an emergency, you might need to borrow money again, potentially at a high interest rate.
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Loan interest rates for many individuals have surpassed 9 percent. This elevated rate undoubtedly strains budgets due to higher interest costs. Considering that these rates are now higher than what many view as safe debt levels, it’s advisable to seriously consider the prepayment option.
Debashish, SEBI Registered Investment Advisor and Founder of Stable Investor, said in an interview that while home loans offer tax benefits that lower the effective interest rates after taxes, those aiming to eliminate debt should still consider making lump sum and/or periodic prepayments. It’s crucial to know what not to do: do not use your emergency fund for prepayments.
Since emergencies can happen at any time, the money in your emergency fund should remain untouched. If you have debt instruments like surplus cash in a savings account, or surplus FD, which earn much lower interest than the interest charged on your home loan, withdraw that money for prepayment and repay it.
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This will immediately reduce your outstanding principal amount and make a difference in the interest charged on it. It would be great if you can increase your EMI by withdrawing some money from your current income