This is a question to which there isn’t a stock answer. It could be yes prepay, for some and no don’t, for others depending on their individual and unique circumstances. There are a multitude of factors which have to be considered before making this decision; answers to the following questions will help you take this decision.
- What does the rest of your balance sheet look like? Your house should not be your only asset. If that is the case, any surplus funds should first get invested to build a diverse portfolio of assets before you start prepaying the home loan. Remember that once you have used up windfall gains, a heft bonus or surplus funds in prepaying a home loan, you can’t get those funds back. Even after a prepayment, you should still have liquid investments like mutual funds, shares etc. that can be easily liquidated for emergencies or other goals coming up.
- What is the rate of return vs rate of interest? If you are using the surplus funds to invest elsewhere and not prepay your home loan, then such investments should grow at a rate higher than your home loan rate. Basically the rate of return you are earning on your investments should be higher than the rate of interest you are paying on the home loan. And remember this is comparison should take into account the tax deductions available on the home loans.
- What does the interest rate scenario look like? If the interest rates are likely to rise, then the either your EMI is going to increase or the loan tenure, or sometimes both. In such cases it may be better to prepay.
- How many years of the loan tenure is left? If you have only 5-7 years left, it maybe better to continue the loan to the tenure. It is always better to make prepayments during the first 5-8 years of the loan as that is when maximum portion of the EMI is allocated towards interest on the loan and hence the prepayment goes towards reduction of the principal.
- Do you have a regular source of income? If the answer is no, then as and when you get lumpsums, you should prepay. If both you and your spouse have a regular stream of income, then it may make better sense tonot prepay but instead invest elsewhere with attractive returns.
- What percentage of your income does the EMI form? If more than 35-40% of your income goes out as EMI, then you should look at making some prepayment of the home loan.
Consider all this factors along with the terms and conditions of prepayment before taking this decision.
The author-Lovaii Navlakhi, CFP is the CEO of International Money Matters and The Financial Alphabet.