With the lending rates of banks are on a rise, the borrowers are geared to pay higher EMIs on their loans. While the banking regulator Reserve Bank of India (RBI) has already raised repo rate by 90 basis points in the past two months, most banks have followed suit by hiking their lending rates, thus pushing the loan EMIs (equated monthly instalments) north.
Most big banks have already raised their lending rates on auto, home and personal loans including ICICI Bank, Bank of Baroda, Bank of India, Indian Bank, Indian Overseas Bank and HDFC.
Time to repay?
So, we explore if this is the right time to prepay the loan, subject to availability of funds – of course. This way, borrowers can avoid paying higher interest rates that are in offing.
Sridharan Sundaram, Founder & CEO of Wealth Ladder Direct, says, “Those who are planning to prepay their home loans have two ways to do so based on the loan tenure left.”
“Let’s suppose, a borrower has anywhere between two to three years of loan tenor left, then one can foreclose the debt, and invest the money in debt instruments or liquid funds. This way, one can accumulate some amount of money during these years,” he said.
Then the second option is to raise the EMI on a regular basis, say 10 percent every year so that your commitment to principal amount keeps rising, and you end up clearing your debt before schedule, he adds.
As we know that during the initial years of home loan tenor, a substantial portion of EMI constitutes interest and only a tiny portion is paid towards principal. As the years roll on, the ratio reverses with lower interest & higher principal amount comprising the EMIs.
This is what Ankur Kapur, Founder of Plutus Capital, underscores when he says that prepayment of loan during the final years of tenor doesn’t make much sense.
“When a borrower is towards the end of home loan tenor, it doesn’t make sense to prepay because by now, most of the interest component would have already been paid. Consequently, the forthcoming rate hikes wouldn’t bring much of a difference,” said Mr Kapur.
He also adds that despite the repo rate hike, we are still 150 basis points behind the pre-pandemic level. “And in case the interest rates are raised by another 75 basis points in the next six to nine months – they would still remain lower than pre-pandemic levels,” he adds.
However, financial experts often advise retail investors to factor in a few considerations before they prepay their debt.
First and foremost, they should not touch emergency fund. Also, they should refrain from redeeming existing investments they allocated for the meeting of financial goals. They should also consider the impact of loan foreclosure on their income tax outgo.