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Old 29th April 2010, 15:17   #1
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Default Is it advisable to pre- pay a home loan

I have a query. Someone taken a home loan of Rs16 Lacs for 240 month. The EMI is around 15440/- per month(@10% interest) . Now i have to asked you that is it advisable to Prepayment of some amount of it. In my opinion ,If you comes into 30% tax slabs then it is beneficial not to prepayment but if you come into 20 % tax slab then it is advisable. This is basis of my Theory :

Suppose you have 16lac with you and instead of spending it on house purchase ,you take home loan of Rs16 Lacs and Fixed deposit this amount for 240 Month.

The value of FD after 240 month (@7% interest , interest calculated Quarterly )= 6410227 /-

As you have paid EMI of 15440/- per month and if you purchase home with your money ,then you can invest this amount in RD for 240 month.

The value of RD after 240 month (@7% interest , interest calculated Quarterly )= 8050148 /-

So you loose 8050148 -6410227 = 1639921 /- after 240 month.

But wait ,wait ..

You also save Rs 45000 per year ( if your slab rate is 30%) or Rs 30000 per year ( if your slab rate is 20%) as income tax saving for the interest amount paid on home loan.

So effectively you save Rs 3750 per month ( if your slab rate is 30%) or Rs 2500 per month ( if your slab rate is 20%) .

So you can invest this amount in RD if you taken home loan .

The value of RD after 240 month for Rs 3750 = 1955185 /-

The value of RD after 240 month for Rs 2500 = 1303556 /-

So effectively you loose (1639921-1303556) Rs 336365 /- if you are in 20% slab but you gain Rs 315264 /- if you are in 30 % slab.

Kindly check it and comment that am I right or not.
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Old 29th April 2010, 15:34   #2
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From next year when DTC comes into force, no form of tax benefit whatsoever will be allowed on home loans.
So i would advice you continue this year and prepay next year when DTC is implemented.
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Old 29th April 2010, 15:41   #3
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For normal wage slaves like the majority of the people around, whenever a block of cash becomes available it is good to pay up a part of one's home loan and reduce outstanding liabilities. This is good thing to do if the property is either self occupied OR even rented out.

The tax free bit is only 1.5 lacs per annum and that also is taken on the payments made towards interest on the home loan.

At 15000 odd EMI, the person would probably be paying more than this per annum on the interest component alone - atleast in the initial years of the loan repayment.

Hence it helps if one prepays a part and reduces the total outstanding.

Consider this:

Home is purchased on a 20 year loan on floating interest (which is pretty typical)
For example if the home cost 10 lacs.
Person has made a downpayment of Rs 2 lacs and taken an 8 lac loan.
He pays an EMI of Rs 7000 per month.
Over 20 years @7000 per month being paid towards the principal AND the Interest, he would have paid up roughly 16.8 lacs to the loan company.

In other words, he would have paid 8.8 lacs by way of INTEREST over the 20 years!

Given this, the home would have had to appreciate to a value of Rs 18.8 to 19 lacs if the man is to break even - and this is not taking into account the potential de-valuation in the absolute rupee value after 20 years.

Effectively it is a gamble on "futures" - whether the total appreciation in value of the property over the 20 year term, will exceed the amounts paid up via interest, downpayment etc and prove to be a hedge against the consistently shrinking absolute rupee value or not.

If it does, then yes, the man has made a nice profit. Even more if the property is self occupied OR even if it is rented out.

This kind of appreciation seems like an easy thing to happen, but lets realize that the artificial property boom which was much in evidence between 2003-2007 is now at a rather low ebb. The next similar boom (from all accounts) may happen only in the next 7 -10 years or so.

Hence, it is good to reduce the overall liability by paying up little blocks of money every so often.

One more thing, it is usually the next generation who will end up enjoying the maximum benefits of property investments made by the previous generation.

Unless one is a speculative investor who is willing to gamble, one has to have a long term perspective when one is investing in property.

If one does make a huge killing in the short term then that is truly a bonus and it frankly is more the exception than the rule.

This is just my considered personal opinion - feel free to refute it or argue it out.

Last edited by shankar.balan : 29th April 2010 at 15:45.
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Old 29th April 2010, 16:01   #4
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I was told by the CA who did my tax returns last year that "never pre-pay a loan" and it was a typical "middle class mentality" to want to be debt free.

Inspite of that we have pre-paid our home loan and now I own my home and car outright. That is a good feeling whatever spin anyone may put on it.
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Old 29th April 2010, 16:19   #5
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Quote:
Originally Posted by Abhay View Post
I was told by the CA who did my tax returns last year that "never pre-pay a loan" and it was a typical "middle class mentality" to want to be debt free.
.
+1.

All the institutions collect EMI with most portion going to interest. So, if you have been paying EMI for years (say 2 ro 3 yrs in case of 10yrs loan period), you would have paid interest upfront. So, why not utilize the money rather than paying back to bank?
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Old 29th April 2010, 16:26   #6
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Quote:
Originally Posted by Abhay View Post
I was told by the CA who did my tax returns last year that "never pre-pay a loan" and it was a typical "middle class mentality" to want to be debt free.

Inspite of that we have pre-paid our home loan and now I own my home and car outright. That is a good feeling whatever spin anyone may put on it.
It definitely feels good to pre-pay a loan and be debt free, I know what you mean; but more often than not, the CAs and economists/investors never advice doing the same.
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Old 29th April 2010, 16:41   #7
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In the initial years, you will be paying more interest than the loan amount.
If the EMI is 15000 then around 75% will go as interest and only the balance amount
will be adjusted into the Loan amount (just for example). So any repayment in the
initial years will give benefit of reducing original loan amount thereby total interest payable will be reduced.?
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Old 29th April 2010, 16:46   #8
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My 10 paise..
  • pre pay - if you have the cash and want a hassle free mind
  • part pay - this reduces the tenure and hence more money goes into the principal part
  • dont pay - ensure that you have an insurance that covers the loan amount which should take care of the outstanding dues in case of any events.
the tax sops that you avail from the interest component of 1.5 lacs and principal upto 1 lac is something that needs to be caefully weighed between key aspects like

1) how desperate are you for the property
2) what is the amount of tax that you save vs. total interest coughed up towards the bank

long time back i remembr an article in the classifieds that had a mathematical illustration where it was proved that you end up paying 0 rupees for your property at the end of 20 year term, if its availed thru home loan ! It was hard to believe, but then I bought my apartment as I was desperate for the property.

Last edited by s3va : 29th April 2010 at 16:47.
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Old 29th April 2010, 16:48   #9
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That is all academic number work. At the end of the day, if someone has spare cash and draws a salary - he wants to reduce his loan (not counting those whose interest exceed the 1.5L limit).

Abhay - that is numerically true. However, tomorrow there may be an accident, there may be ill parents, you may lose your job. Do you still want to have a large fixed monthly outgo?

I know someone who got cancer at age 21, another very fit maha meditation types person got it at 23. The reality is that life is uncertain. And a large fixed monthly outgo is a pain.

Of course, at any one given time, you should have enough cash in the bank for a minor emergency.
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Old 29th April 2010, 16:51   #10
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Quote:
Originally Posted by DCEite View Post
From next year when DTC comes into force, no form of tax benefit whatsoever will be allowed on home loans.
So i would advice you continue this year and prepay next year when DTC is implemented.
Please elaborate on this. What is DTC? I am also planning to prepay about 50% of the principal amount and this is important.
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Old 29th April 2010, 17:01   #11
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Quote:
Originally Posted by mail4ajo View Post
Please elaborate on this. What is DTC? I am also planning to prepay about 50% of the principal amount and this is important.
DTC is direct tax code to be implemented from next yr.

From: OUTLOOK - Blogs

"
BLOGS / Sunil Dhawan
Direct Tax Code: Impact On Home loans

The Direct Tax Code Bill, 2009 proposes to drop tax benefits on home loans. Once the proposal goes through, the existing tax benefit (principal deductible up to Rs 1 lakh and interest up to Rs 1.5 lakh a year) would not be available. This would be true in the case of loans taken for self-occupied houses, but not for those on rent.
Not many who take a home loan to fund his or her dream home do so for tax benefits. But then, the tax benefit certainly helps lower the overall cost of financing the home.
Would that make any difference to existing home loan borrowers?The Code would also apply on existing loans once it gets passed. The existing home loans buyers have nothing much to work on. No one is expected to exit from the home loan in the absence of tax benefits.
What about new buyers?
For new buyers, the math certainly changes. The tax figures helped people favour ‘Buy’ in the “Rent vs. Buy” comparison. With no tax benefits, the combination would now seem to tilt the other way.
"
From:Direct Taxes Code: How you are affected!: Rediff.com Business

Impact on home loans
"
Currently, if you have taken a home loan, the interest payments up to Rs 1.5 lakh (Rs 150,000) and up to Rs 1 lakh (Rs 100,000) towards principal repayment are eligible for tax benefit.

But this is set to end once the new code comes into effect. So if you have paid Rs 3 lakh as interest and Rs 2 lakh as principal, you will not get any tax benefit. However, if you have rented out a home, you can still avail of the tax benefits for taking the home loan.
"








P.S. Just wanted to clarify- for rented out house, the tax excemption will still exist.

Last edited by DCEite : 29th April 2010 at 17:03.
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Old 29th April 2010, 17:35   #12
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I faced a similar predicament last year. I have an outstanding of about 10L on my current home and have that much cash. After thinking long and hard, I decided against pre-paying that loan and instead made the down-payment on another home.

I am hopeful that within 3-4 year, my investment will be more than doubled and it'll be much more than what I could have saved in interest.

My two cents :-)

Nitin
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Old 29th April 2010, 17:48   #13
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I think when people are thinking of pre-payment, it is assumed that they have enough money in the bank for emergencies like medical, loss of job,etc. If not that should be the first priority.

Now, with the remaining part, it depends on what you can do with the surplus cash. If you have an option to generate more returns than the housing loan interest rate, use it for that investment ( like ntomer did above ). If not, pre-pay the loan.
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Old 29th April 2010, 18:09   #14
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Quote:
Originally Posted by DCEite View Post
But this is set to end once the new code comes into effect. So if you have paid Rs 3 lakh as interest and Rs 2 lakh as principal, you will not get any tax benefit. However, if you have rented out a home, you can still avail of the tax benefits for taking the home loan.
"P.S. Just wanted to clarify- for rented out house, the tax excemption will still exist.
Can someone please explain why it is so that the tax exemption will continue for a rented-out house? What's the logic/thinking behind that?

Does it mean that if someone buys a home and lives there, he can't avail any benefit? But if he buys a second house and lets it out on rent, he can claim benefits for the second house?

Quote:
Originally Posted by ntomer View Post
I faced a similar predicament last year. I have an outstanding of about 10L on my current home and have that much cash. After thinking long and hard, I decided against pre-paying that loan and instead made the down-payment on another home.
That's exactly what I did too. So now I have two home loans. One house has been rented out (and it helps me pay half the EMI). I live in the second house and having moved from Bangalore to Cochin, the EMI on my new house works out to be lesser than the rent I used to pay in Bangalore!
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Old 29th April 2010, 21:33   #15
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There is one more angle to this. If you have that much cash to pre-close a HM & if you are not burdened by the EMI plus deriving tax benefits then why pre-close ?
Get some piece of land where there are chances of appreciation and sell it later if stagnant. Use this cash whereever required.

Plus if you have 10 L outstanding and you pay up 5 L then whether only 5L would be remaining or 5L + Interest calculated would precipitate needs to be cleared from the bank. There are some Governement banks which will show 5 L outstanding but I do not know about private sector banks. This needs to be cleared.

Last edited by prince_pervez : 29th April 2010 at 21:35.
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