In another round of discussions surrounding inflation and interest rate decisions, the Reserve Bank of India (RBI) raised the key policy (repo) rates by 50 basis points to 4.90 per cent. To contain inflation, the RBI increased the repo rate two times in May and June by 0.9 per cent which is slated to go up further considering the current trend in worldwide inflation. The repo rate hike has a direct bearing on the interest rates charged by various banks and other lending institutions. This means that borrowers who had sought loans on a floating rate basis will not only have to pay more at the current rates but more in future too. This is because with the interest rates going up, borrowers will now have to pay higher equated monthly instalments (EMIs).
Considering how EMIs can take a toll on your financial health, it makes sense to design a strategy that will help you reduce not only the outstanding loan amount but also reduce the burden of the EMIs that must be paid to reduce the liability. One way is to prepay a part of the loan amount, thus, accounting for partial prepayment of the loan amount. Though not all borrowers may not be in a position to prepay a part of the loan amount considering the unavailability of so much income and other overriding expenses, loan prepayment is the first step you must consider to reduce the burden of any loans sought. This is especially true of those repaying home loans as these are the cheapest among all other loan products available in the market.
How does loan prepayment help?
We all know of the ₹2 lakh deduction availability under Section 24B of the Income Tax Act, 1961. The benefit of this deduction on the interest paid towards home loan repayment of a self-occupied house can be used not only to lower our tax liability but also to repay the loan quickly. For example, those falling in the 20 or 30 per cent income bracket
However, this benefit is subject to the current home loan rates. Borrowers are anticipating higher interest rates in the near future. Even a percentage hike in interest rates would erase the benefits as the interest outgo every year would already exceed ₹2 lakh. Prepaying a loan up to ₹2 lakh in a year would not help as the Act does not lend benefits beyond this amount. The following has been explained in the following table.
Loan Amount or Principal (in Rs)
Loan Interest Rate (in %)
Loan Tenure (in years)
Monthly Interest Outgo (in Rs)
Source: HDFC Online Home Loan Calculator
Use surplus to prepay your loan
It is common behaviour to park surplus funds in fixed-income products. However, not many realize that the interest paid on home loans exceed the interest received on fixed-income plans. Add to this the effect of taxes, and you will realize how the interest earned on fixed-income plans is absolutely minimal. This is one good reason why the current home loan borrowers must use their surplus income to pay off their loan interest amounts instead of investing it in low-yield income products.
Many people invest in avenues that generate returns over and above the rate charged on home loans. In that case, prepaying a home loan just to benefit from Section 24B of the Act does not hold valid ground. To check this, you must evaluate in detail to check if the post-tax return on the investments you made is more than the amount you save through taxes.