Think be­fore you fore­close your loan

Con­sider your port­fo­lio’s av­er­age re­turn and fore­clo­sure charges be­fore tak­ing the step

The Hindu Business Line - - YOUR MONEY - NALINAKANTHI V Con­sider

If you’ve got a good bonus and have some loans on­go­ing, the first thing that pos­si­bly comes to your mind is to pay off the loans and any other high-cost debts. But that isn’t a straight for­ward de­ci­sion as it may seem. There are a few points that you need to keep in mind be­fore de­cid­ing to fore­close a loan us­ing any sur­plus cash.

The first ques­tion that needs an­swer­ing is the cost of the loan and the av­er­age re­turn on your in­vest­ment port­fo­lio. Let us un­der­stand this with an ex­am­ple. Ms A is a con­ser­va­tive in­vestor and has parked most of her sur­plus funds in fixed-re­turn in­stru­ments. Her in­vest­ment cor­pus fetches her an av­er­age pre-tax re­turn of, say, 8 per cent. She has a home-loan out­stand­ing to the tune of ₹30 lakh on which she pays an an­nual in­ter­est of 9 per cent.

Given that her cost of loan of 9 per cent is higher than the in­ter­est on his in­vest­ment, she may be bet­ter off pay­ing of her loan/debt as and when he has some sur­plus money, un­less she plans to in­vest in a dif­fer­ent as­set class such as eq­uity which can fetch him a re­turn higher than the in­ter­est on her loan.

Al­ter­na­tively, if A is an ag­gres­sive in­vestor who has in­vested in other higher re­turn-bear­ing as­set classes and earns an av­er­age re­turn of 12 per cent, then she should con­sider in­vest­ing the ad­di­tional sur­plus, as she can gen­er­ate higher re­turns by in­vest­ing, and use the pro­ceeds to pay her loan in­ter­est.

Fore­clo­sure charges

Sec­ond, there may be a cost at­tached to pay­ing off a loan early. Banks typ­i­cally charge a pe­nal in­ter­est if you want to pre-close your loan; this is called fore­clo­sure charges.

The fore­clo­sure charges vary across loan prod­ucts and fi­nanciers (banks and non-bank­ing fi­nance com­pa­nies).

Ac­cord­ing to a di­rec­tive is­sued by the RBI, banks can­not charge a pre-pay­ment penalty on home loans that have a float­ing in­ter­est rate. How­ever, if you have a fixed-in­ter­est-rate home loan, you may have to pay pre­pay­ment charges. For in­stance, ICICI Bank charges 2 per cent on the resid­ual prin­ci­pal for pre­pay­ment of a fixed-in­ter­est home loan.

In case of a per­sonal loan, the pre-clo­sure charges can be a bit high. While pri­vate banks and NBFCs charge you for pre-pay­ment, pub­lic sec­tor banks such as State Bank of In­dia do not.

Citibank, for in­stance, charges 3 per cent for a per­sonal loan; HDFC Bank charges 4 per cent. NBFCs such as Cap­i­tal First charge 5 per cent for pre-clo­sure.

The rates for part-pay­ment of a per­sonal loan also vary across banks. For in­stance, HDFC Bank al­lows part-pay­ments only after com­ple­tion of 12 months. For part pay­ments from 13 to 24 months, a fee of 4 per cent is ap­pli­ca­ble on the part-pay­ment amount. If you wish to make the pay­ment from 25 to 36 months, the ap­pli­ca­ble in­ter­est rate is 3 per cent. In case you want to make part-pay­ment 36 months after get­ting the loan, you will have to pay 2 per cent of the amount be­ing re­paid as pre-pay­ment charge.

Also, banks re­strict the num­ber of times you can part-pay in a given year. HDFC Bank for in­stance, lim­its it to two per year.

While, it is pru­dent to pay off li­a­bil­i­ties early, pay at­ten­tion to the pe­nal in­ter­est and your in­vest­ment re­turn be­fore you go ahead and fore­close your loan. Also, keep in mind the fore­clo­sure charges while ze­ro­ing down on your lender; this can help you pay off your loans with­out caus­ing a big hit to your pocket.

The writer is an in­de­pen­dent fi­nan­cial con­sul­tant No pre­pay­ment fee on float­ing-rate home loans

Part-pay­ment at­tracts penalty; some banks re­strict num­ber of pay­ments

Pre­pay your loan only if your in­vest­ment re­turn is lower than loan in­ter­est

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