As a consequence of the recent hike in the cash reserve ratio (CRR), banks have yet again hiked the home loan rates. Higher rates are not only increasing the cost of home acquisition, higher EMIs are also putting tremendous pressure on monthly budgets.

In such a scenario, the loan taker has three main options - pre-pay a part/whole of the loan, switch to a fixed-rate loan, or opt for an increase in tenure. We explore each of these three options.

Prepayment of loan

The fundamental question is whether it is wise to prepay even at this time. “You can prepay the loan provided you have investments profits from equity or additional surplus after meeting all commitments,” says a certified financial planner and a chartered wealth manager Kartik Jhaveri.

Industry experts say that a borrower should not prepay the loan with the only intention of keeping the EMI constant. Usually, with the incremental income, borrowers can absorb the rise in EMIs. What a borrower should calculate is the optimum EMI he can service with a possible rise in the salary.

Says UTI Bank’s head—retail assets, Sujan Sinha, “Every borrower is comfortable with a certain amount of deduction. So, a borrower can partly pre-pay the outstanding loan amount such that the interest and the principal outgo remain unchanged.”

When should you prepay the loan? This decision can be tricky too. While prepaying principal reduces the liability and the cumulative interest one will pay, it can also reduce the ability to take full advantage of the tax benefits on home loan interest.

So, if you want to control your overall absolute cost of acquisition, prepayment in the initial stages can be fine as maximum interest is chargeable then. However, if it is advantageous to claim full tax benefits, it may be better to stick around till the later stages of the loan. That is the time when interest component in an EMI is low and principal is the dominant component.

“Let’s assume you have borrowed Rs 30 lakh for 15 years. The total pay out for the first year aggregates to over Rs 4 lakh, principal accounts for almost Rs 76,000 of this outgo. In the last quarter of the loan (after 10 years), the outstanding principal is over Rs 16 lakh.
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