Have you had a look at your interest certificate for the current financial year? If your home loan is just about a year or two old, chances are that you might be deeply disappointed with what you see. The principal re-payment has been negligible vis-à-vis the amount you see allocated towards interest cost. Why did this happen?
Look at the amortisation schedule of your home loan. Look for rows that say “interest rate revised from X to Y”, Y
being higher than X. As a consequence of the above you may have received emails or letters of intimation or calls that your revised tenure has gone up by many months or that you need to pay higher EMI. Either way this is just so detrimental from the borrower’s perspective.
Home budgets go out of order and cashflows go awry.
As a result we have that choking feeling and almost as if someone is looting us in broad daylight. But lenders cannot help that. In order to lend to us they have themselves borrowed from someone and their interest cost may also be moving up. They simply pass it onto us i.e. the consumer. That said institutions are far more astute in managing their liabilities and
often we are not. So each year as our
income moves up we feel that we are able to manage and thus we tend to defer the problem. We must note however that growth of income does not imply growth in EMI, else when will wealth be created if you keep re-paying loan forever. Is there a remedy? People tend to pre-pay as and when they have money but this is more like blind prepayment. Consider timed prepayments.
Prepayments essentially mean an out of turn lumpsum payment/s towards your loan principal which may be done either in part or in full. The effect of such prepayment is that it enables us to repay the loan faster. That said prepayment is a very good idea but blind ignorant prepayment tends to be unwise. There are some rules and methods if applied tend to make your prepayment most effective.
We keep an example in reference: Rs 50 lakh borrowed hence EMI of about Rs 50,000 per month at an average rate of interest being 11 per cent. The tenure of loan being 20 years the total interest payable is about Rs 74 lakh over 20 years.
Prepayments from savings
Now by making a prepayment of say just about 5 per cent or about Rs 2.5 lakh, say in the 13th month, you can save as much as about Rs 14 lakh of interest cost. Instead of 13th month if you do this in 37th month you will save about 10 lakh only. How do you go about creating this Rs 2.5 lakh sum? Save Rs 20,000 per month in a recurring deposit for 1 year or about Rs 10,000 in a similar deposit for say 24 months. It could also be random sums placed in deposits that you did not need to use towards your living expenses on a monthly or quarterly basis. If you think about this it may not be as difficult to create such little savings. Plus you have the advantage of no prepayment penalty as well.
Prepayments from profits
Here’s a better idea. Why not use some part of your profit that has been generated from your equity mutual fund investments? At the moment you might feel that you have not made enough money, leave aside profits. For this you need to understand a little bit of economics. When deposits rates rise it means lending rates will also rise; which means that large companies will need to shell out more towards their borrowing. This results in a reduction of their profits and thus their stock price tends to fall. As a result you are nursing losses. However when the situation changes i.e. to say when interest rates fall it means there is now access to cheaper money. Thus profits will increase and will eventually reflect in the share price. So if you have been holding stocks or a portfolio of stock via a mutual fund for 5—10 years there would always be profit to talk of. Consider using some of this profit to make that prepayment.
Key takeaways
There are four things to consider while making a prepayment viz, timing of the prepayment, interest rate situation, your investment position and your loan position. This is crucial. Unless all of this is planned and balanced well, your prepayments will be like firing empty shells with no impact. So whenever you have funds the next time, try to control that natural urge to go ahead and prepay.
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