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9 tips to close your home loan in the New Year

Last updated on: December 19, 2011 18:23 IST

9 tips to close your home loan in the New Year

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Salil Dhawan, Investment-mantra.in

Here are a few useful recommendations to help you close your home loan early and save on interest costs.

Most home loan borrowers in India strive to pay off their entire loan in 5 to 7 years, despite the tenure ranging from 15 to 25 years. They want to call their dream home completely their own as soon as possible and, hence, the hurry to get rid of the debt.

With the interest rates continuing their journey upward resulting in additional pressure on household expenses, borrowers are forced either to increase their home loan EMIs (equated monthly installments) or make a prepayment on the loan to keep home loan duration under maximum permissible limit.

Irrespective of where interest rates are, home loan borrowers should look to aggressively pay back their home loan by doing partial prepayments from time to time whenever possible. Some borrowers are of the view that it may be beneficial to prepay the home loan only early in its tenure and not after it has passed the mid-way mark. This is not necessarily true. You may think that the EMI will, for the remaining part of the repayment period, mainly go towards clearing the principal amount as much of the interest portion has already been paid off. Even though this is true, the effective cost of the loan remains the same. Hence your decision should not change based on how much tenure of the loan has already elapsed. Make sure you bring your home loan at comfortably manageable levels with course of time.

Courtesy: Investment-mantra.in


Photographs: Rediff Archives
Tags: EMI , India

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Why paying off your home loan quickly makes sense?

One of the best ways to save money on your mortgage is to pay it off as fast as you can. The longer you take paying off the principal loan the more interest you pay along the way, and the higher the overall cost of the loan. So make sure you design a plan to pay off your home loan sooner.

Extra repayments at any time help reduce the time and cost of a loan. But for maximum time and cost savings, one should make extra repayments earlier, rather than later -- thanks to the powerful effect of compounding interest over time.



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9 tips to close your home loan in the New Year

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1. Reach on prepayment amount to be done in the New Year and plan accordingly

Make sure at the beginning of the New Year itself you reach to the amount you plan to prepay for home loan principal. It will help you to set aside a definite amount every month towards this goal. For instance, if you decide to pay back Rs 120,000 in the coming year as part of home loan prepayment, you can look to set aside Rs 10,000 per month to reach that goal.

In nutshell, you can consistently do part-prepayment, say every quarter, and conserve some of your savings for this purpose every month. This will bring down the principal you owe to the bank, thereby reducing the outstanding loan amount and hence the net interest you will end up paying will consistently drop down.



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9 tips to close your home loan in the New Year

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2. Building an emergency fund

This is the basic rule of financial planning. Make sure you build up an emergency fund of 3 to 6 months so as to take care of any unforeseen expenses. It will also help you not to shell out funds you are saving for prepayment of the home loan. In nutshell, you need to ensure you have enough liquid savings to handle emergencies such as unexpected medical expenses.

3. Utilise your year-end bonus to prepay the home loan

This can be a smart option for those looking aggressively to prepay their home loan. If your yearly investments, expenses, emergency fund etc are in place, using your year-end bonus to prepay home loan can be a smart option.

4. Look at your home loan yearly statement

This statement will give you an idea as to how much amount of your monthly EMI is going towards the principal component and how much is the interest component. Many borrowers seldom see home loan statements and thus are unaware of huge interest component they are paying.



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5. Aggressively look to prepay if your salary increases

Increase your contribution to yearly prepayment corpus (discussed in point 1) if your income increases. If you receive a raise each year, it would be sensible enough to divert your funds towards this goal unless you require the money elsewhere.

6. Look to invest in mutual funds

Another sensible option can be to invest a definite amount each month in a well-diversified mutual fund with a goal of prepayment of additional principal after couple of years. Since an ideal investment in mutual fund should be more than 5 years, you can continue investing in the fund for more than 5 years and then use that money to prepay the principal. It can be a smart option since here you can expect to earn 12 to 15 per cent tax-free returns. This can be in addition to prepayment amount to be shelled out each year as mentioned in point 1. You can also have a look at balanced funds for this purpose.



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9 tips to close your home loan in the New Year

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8. Home loan prepayment penalty removed by most of banks

Do remember, some time back RBI had indicated that banks would be required to scrap prepayment penalties. The charges are waived off on prepayment charges for all customers -- new or old, fixed or floating -- and irrespective of whether they are paying from their pockets or switching to another lender. For instance , State Bank of India (SBI) has announced removal of prepayment penalty on home loans with immediate effect. The bank had been charging around two per cent of outstanding principal as penalty if the borrower opted to foreclose the loan.

ICICI Bank too, removed prepayment charges for floating rate loans.

Home Loan borrower thus has another reason to aggressively pay off home loan since one will be saving on considerable interest outgo if one can focus on directing the savings towards prepaying a significant part of the loan during the first five years and that too without any prepayment penalties. Prepayment of any amount without penalty in case of floating rate loan is a great step indeed.

If your loan has the flexibility to allow increased regular repayments and lump sum repayments without penalty, take advantage of it whenever you can.




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9. Increase your EMI if you can't make prepayments for now

Those borrowers who may not be able to prepay large chunks of the loan during the initial years can consider increasing the monthly installment to the extent their affordability permits. Typically, when the interest rates go up, it's not the EMI amount but the loan tenure that sees an expansion. This thus makes the overall interest load heavier for the borrower. To minimise the burden, one can look at increasing the EMI by at least 10 per cent. Even a one-percentage point increase in the interest rate can lengthen your loan tenure substantially. Make sure you are completely aware of such facts and act accordingly.

Summary

Do remember, saving on the net interest is the most significant advantage of prepaying the home loan, other than the fact that you will retain the complete ownership of the house earlier than planned. The longer the loan tenure, the more the interest repaid, hence its best to repay your home loan in the shortest loan tenure possible, provided it can be managed comfortably within your income. The more you pay off your home loan, the more of the property you own, and the more equity you build up.



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