The year 2022 was not great for home loan borrowers. Those who borrowed before May 2022 saw their EMI (equated monthly instalments) rise with every repo rate hike.
In the last eight months alone, while repo rate increased by a total of 225 basis points, home loan interest rates increased by more than 100 basis points.
For borrowers with credit score of 800 and above, home loan interest rate which was 6.7 percent in April has increased to 8.65 percent. This left borrowers with two options. Either they could pay a higher EMI or let the loan tenure stretch by a number of years.
However, the better alternative, advise wealth advisors, is to prepay a part of the loan to spare yourself from paying EMIs for an extended duration.
Should you prepay your loan?
Let us take a hypothetical situation: if you have some money, say ₹5 lakh at your disposal, should you prepay your home loan or invest that money in a fixed income instrument? Well, investment advisors suggest that you should use the spare sum to prepay a part of your home loan amid the rising interest rate cycle.
Kirtan A Shah, Founder of Credence Wealth Advisors, says that prepayment of your loans makes a lot of sense in a rising rate environment. After all, a 20-year loan taken in Jan 22, has now become a 33-year loan because of increasing rates, assuming that ₹10 lakh loan was taken for a period of 20 years.
The rationale is simple. When you prepay the loan, you save on interest outgo which currently hovers around 9 percent. This gets a further impetus since the earnings on fixed income instruments are currently lower than the current interest rates on home loans.
This means if you decide to park some of the money in a bank instead of using it to retire a part of the debt, you earn less than what you will eventually pay in form of interest.
Atul Monga, CEO and CO-Founder, BASIC Home Loan, says that extending the loan tenure is not advisable since it makes you pay an interest at a higher rate.
“It is best for home loan borrowers to opt for prepayment of loan, especially earlier in the loan tenure when the interest component also remains high. Even if the interest rates are higher and you pay more than your EMI, it will reduce your principal amount and your overall interest charges will go down. On the other hand, extending the loan tenure simply means you are paying more interest to the bank at a higher rate,” said Monga.
(For a loan of ₹20 lakh taken for 15 years)
As one can see in the table above, the EMI amounted to ₹17,643 for a loan of ₹20 lakh taken for 15 years before the rising rate cycle came into effect. The EMI rose to ₹18,089 in May when the interest rate was 7.10 percent, and it eventually peaked to ₹19,871 towards the end of 2022, thus adding a total of ₹2,228 to each instalment.
However, if you decide to stretch the loan tenure, it would have stretched by more than four years i.e., a 15-year loan gets additional 55 EMIs with the EMI amount remaining constant, as any home loan calculator would indicate.
Sreedharan Sundaram, a Sebi-registered investment advisor and Founder of Wealth Ladder Direct, says that prepaying the loan is ingenious when the other alternative is to either keep money in an FD (fixed deposit) or a debt fund because the returns in these instruments are lower than the interest on home loan.
“This is the time to prepay the loan because the interest rates are high while returns on debt instruments are hovering around 6 to 7 percent. So, even if you park money in debt instruments or term deposits, you will not earn much and will end up losing money in form of accrued interest on home loans which is hovering around 9-10 percent. So, if you have some disposable corpus – it is advisable to prepay a part of your liability,” says Sreedharan.