Many of you would have home loans, which you so desperately want to get over with. Isn’t it?
And there is absolutely no denying that loans come with a mental burden that gets relieved only when it is settled.
This is one of the major reasons why many aggressively repay their loans to close them much ahead of the schedule. The obvious mathematical reason is known to all. Home loan prepayment helps reduce the interest (total interest paid) and thereby, reduces the actual landed cost of the property.
So many who want to aggressively repay their home loans, take a notional holiday from everything else. Whenever they can, they just use the surplus funds to prepay and reduce the outstanding loan amount.
But is such an obsession with home loan repayment good?
Well, this can be debated.
But the first thing to understand here is that repayment of home loan is non-negotiable and important but a faster prepayment of the loan is not the only thing in life.
There are other financial goals that require savings and which cannot and should not be ignored.
It’s natural for people to feel that as there are several years left before other goals (like children’s education, retirement), so why not first tackle the home loan and then go after those goals?
There is no doubt that it can be done. But with each passing year of delay, you will have to save more money to fund these goals. Who knows whether it would be possible for you now and not then? Life can surprise. At times pleasantly and at times not so pleasantly.
That’s not all. There is another school of thought that argues that since post-tax home loan rates are quite low, the surplus money can be invested elsewhere (at higher returns) and be used after few years to close the loan in one go. That is correct too for a small subset of borrowers who wish to go down that track.
So what is that one should do?
Obviously, there can be many strategies depending on what the individual’s situation is.
But here is what can be considered to push you to think further:
> First, take care of your regular home loan EMIs and family’s basic expenses.
>Second, gradually save some money for emergencies. Whether it is worth 1, 3 or 6 month’s worth of expenses, is up to you. But a healthy emergency fund should be of at least 3 to 4 month’s worth of expenses. Put it in place as soon as you can.
>From the remaining surplus, start investing for other critical goals like children’s education, retirement, etc. Don’t worry if the amount you can save is small. Just do it.
>If you still have some surplus left, then you can think about whether to prepay or not.
>You can either be conservative and use this surplus to prepay extra every month or do so less frequently by combining the accumulated monthly surpluses with your annual bonus and using it to prepay the home loan once a year.
>If you are more adventurous, then there is another option. You should start investing the monthly surplus in equity-focused mutual funds. Assuming you keep doing this for several years and markets on average give higher returns than what your home loan costs, you can save up a decent corpus. This corpus would be available to you to close the loan in one go when the corpus becomes larger than the loan outstanding. What’s happening is that you are investing the surplus every month meant for prepayment, but are postponing the actual prepayment to a future date.
>The saved money also acts a neat buffer for situations where you are caught in temporary liquidity crisis which might make regular EMI payment difficult. You can always dip into the buffer and smoothen your financial life. Isn’t it? Or if suddenly the floating home loan rates are hiked, you can make some large prepayments to reduce the outstanding and save on the interest.
But I must say this again here.
There is no one perfect way to handle this. Depending on the individual’s unique situation, the suggested strategy might be different.