Home loan EMIS set to rise, but don’t rush for prepayment
NEW DELHI/MUMBAI: Worried about upcoming RBI rate hikes and planning to prepay your home loan? Think again: home loan EMIS come with tax breaks, and you could, in fact, save some money by keeping a home loan alive.
If you are paying a home loan rate of 9% with a remaining tenure of 10 years, it makes financial sense to keep a ₹ 23 lakh of loan alive.
Vishal Dhawan, founder and chief executive officer, Plan Ahead Wealth Advisors, said that if a home loan borrower has surplus liquidity and she is fairly sure that it is not needed for any other financial goal, then it is a good idea to repay, partially or fully.
“For people who do not have the surplus liquidity, they need to ensure that they keep their tenure intact by increasing their EMIS, rather than allowing the tenure to go up, and therefore ending up paying more interest,” he said.
You know that you are eligible for a deduction of ₹ 2 lakh under section 24(b) of the Income Tax Act, 1961, from your taxable income for the interest you pay on your home loan. The idea is to keep the loan amount at a number that gives you an interest cost of ₹ 2 lakh a year to milk the tax break fully.
For example, if your home loan rate is 9% and the remaining tenure is 10 years, then a home loan amount of ₹ 23 lakh will give an interest cost of ₹ 2 lakh. At 9.50%, the optimal loan amount is ₹ 21.75 lakh. The higher the interest rate, the less loan you should keep.
The lower the rate, the higher the loan amount you can keep. As interest rates are rising, the amount of loan to keep goes down.
What’s the math? When you get a tax break on your home loan interest, the effective cost of the loan goes down. If you are in the highest tax bracket of 31.2%, a 9% loan will cost just 6.2% if your loan amount is ₹ 23 lakh.
Suppose your large-cap equity fund is giving you an annual return of 10%, then it makes sense to keep the money in the fund and pay an interest of 6.2%, rather than break the investment and prepay your loan. You can prepay the amount in excess of your ideal home loan amount.
Most home loan products are already more expensive post the previous rate hike by the Reserve Bank of India. Expect another round of rate hikes on your home loan soon. But remember to not rush in to prepay.