Getting Bonus or hike? Should you pre-pay home loan or interest?

 Many salaried individuals are about to get their annual bonus credited to their accounts. There are definitely some or the other plans that we all have while receiving money like-to spend them, to invest them or to use them against any loan or outstanding liabilities. 

Home loans are not just about paying off the principal amount. They carry interest too. Majority of loans carry an interest around 7 percent. The burden of interest depends a lot on how many years are still left for the outstanding amount to get over.

The return that we get from the market linked securities or fixed income sources, need to be compared with the home loan interest rates in order to take a better financial decision. 

It all depends upon an individual’s choice. One may like to just get over the debt and may not be comfortable with a large housing loan. By paying it off it is easy to get rid of the stress as soon as possible. It is advisable to prepay the outstanding loan considering the probabilities of job loss, death of the bread earner in the family, serious ailments and so on. Clinging to the number game won’t help you make a decision if you do not like carrying the burden any longer. 

On the contrary the regular IMI holds some tax benefits. If it is not bothering you, you may choose to continue with it. Under section 80C of the Income Tax Act, the principal amount is treated as an investment (maximum limit Rs 1.5lakh including PPF, insurance etc). Interest component is deductible under section 24. The maximum amount that one can claim by way of interest is subject to a limit of Rs.2lakh annually.  Beyond this limit deduction cannot be claimed. So in a case where the interest amount is more than Rs.2lakh, it is advisable to pay off the loan. A person falling in a 30 percent tax bracket can save Rs.60,000 towards taxes by claiming the interest deduction.

But when the loan is shared jointly with the spouse, both the husband and wife can claim Rs.2lakh individually against interest payment. 

Sometimes it is better to create an emergency fund rather than prepaying your home loan when the interest is less than the maximum limit. 

When you are in a position to earn post tax returns higher than the effective cost of the housing loan, you can continue doing so without hurrying to prepay it. If the risk appetite is more, prefer long term equity investments. These investments might fetch you a return equivalent to 10-15 percent. But in that case it is important to know the market risks as well.

Few home loans offer overdraft facility to let you maintain liquidity. Consider them as prepayment only and invest your money in them. It is like prepayment with the option to take out the money. By using this effectively, you can keep the interest amount around Rs. 2lakh to earn maximum benefits. SIPs can be managed from this account. 

Prepaying the loan when the interest rates are lower, would be a smart option as the payment that you make will get adjusted towards the principal and that will ultimately reduce the burden of loan. 

The banks usually do not allow prepayment in the first six months after getting the loan. The number of times that you make pre payment and the minimum amount by way of prepayment are decided by the bank.

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Krishna Rath is a SEBI Registered Investment Adviser, and since 2015 has been educating netizens on investments and insurance. Krishna is a fee only SEBI RIA and is Odisha's first SEBI RIA. With background in IT, Krishna is changing the advisory space with new innovations in AdvisoryTech.

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