Prepay home loan or step-up investment? Here’s what you must do with your annual bonus

Who doesn’t await their annual bonus? Well, you sure are excited about receiving this sum that you can use in a myriad of ways. However, we suggest you use it to enhance your financial standing. Now, you may wonder, should I use the amount to pay the equated monthly instalments (EMIs), make a pre-prepayment, or add that amount to my ongoing investments. Let’s try and arrive at a logical decision. 

Home Loan Prepayment – The Right Move

We cannot agree more that deciding between home loan prepayment or investment is quite difficult. This is especially true at a time when the rate of interest in the market is fluctuating immensely.

Prepay home loan or step-up investment

At present, the rate of interest on fixed-income investments has been hovering around 5%, whereas the rate of interest levied on home loans is around 7%. 

Making the Better Pick

Let us assume that you have an ongoing home loan of Rs50 lakh. Additionally, you have borrowed the sum with the promise to repay the same within a loan tenure of 20 years. If you service the loan at an interest rate of 7%, you pay a monthly cost of Rs38,765 in the form of EMI. When you total the costs for an annum, it comes to Rs4.65 lakh.

Directing your annual bonus towards your home loan will help bring down the costs of your outstanding principal amount. Simply put, it reduces the debt that you owe the bank. A reduced principal also brings down the overall costs that you pay on the loan throughout the term.

If you continue to pay your interest against the same interest rate of 7% for the given number of years, your interest outgo sums up to Rs43.03 lakh.

Suppose you direct a sum of Rs1 lakh from your annual bonus towards the prepayment of your home loan each year. Now, you can save up to Rs13.82 lakh throughout the loan tenure. You ask how? Paying up Rs1 lakh on your principal amount in the first year itself will reduce your total interest payment from Rs43.03 lakh to Rs40.40 lakh. As you continue to use your annual bonus, the amount further reduces, easing your home loan costs.

This saving is significantly higher than the returns that you could make through investing in fixed investment instruments such as FDs. 

Repay When the Interest Rate is Low

If you have now decided to make your home loan prepayment, you must also note that it’s best to do it when the interest rates are low. Making repayments when the interest rates are comparatively lower is the best way to make bigger savings. It aids in clearing a bigger amount of your principal loan amount, further reducing the loan tenure. 

Do I Lose on Penalties?

Often, there are penalties involved in prepaying your loan home loan. This aspect completely depends upon your bank. There may be a cap on the total number of partial prepayments that you can make during a given period. Also, most banks do not allow prepayment in the first six months to 1 year of the loan tenure.

You should also note that making prepayments could lead you to losing out on the income-tax benefits that you currently avail. Section 80(C) of the Income Tax Act, 1961, enables you a deduction of up to Rs1.5 lakh on your home loan principal. Evaluate this factor carefully to ensure that the savings are marginal.

To Conclude…

Making home loan prepayments or stepping up your investment plans, either way, helps strengthen your financial backing. The fact that you have decided between the two options is notable of your intention to use your available funds productively. Visit Finserv MARKETS today to know of other investment and savings opportunities that you use to your advantage.