When you’ve got a bonus or if you earn some extra cash, the first thing that comes to your mind is to reduce the amount of debt that you may be under. Some people may even opt to invest the extra money to utilise it for generating additional income. However, the general opinion on how you should utilise these funds is quite varied. Read on to figure out the answer to the big question; to prepay or not to prepay?
What is Prepayment?
Prepayment is an early payment of the loan amount, over and above the regular EMI. Prepayment can be done in part or as one big lump sum depending on the funds in hand. Home Loan repayment is a long and tedious affair and it’s no surprise that that’s the first thought that comes to your mind when you have extra cash in hand.
Advantages of Home Loan Prepayment
Home Loan EMI calculation is done using an EMI calculator. Anything you pay above this EMI amount is known as prepayment. Below are the advantages of prepaying your loan:
- Interest Reduction: Your initial EMIs are used to clear of a larger chunk of the interest when compared to the principal amount. If you prepay your loan to some extent, you’ll be getting a lot of relief on the interest front. As mentioned earlier, repaying a Home Loan is a lengthy affair; the sooner you clear it off the better for your financial health.
- Credit Score: One of the biggest benefits of prepayment is the effect it has on your credit score. Your credit score will improve drastically if you prepay your loan. It shows lenders that you are financially stable and are careful with your money and debts. This makes it much easier for you to get another loan if you ever need one in the future.
- No Prepayment Charges: The RBI’s current policy states that banks can’t charge for prepayment. This means you can prepay your loans how many ever times possible without incurring any cost. In essence, you can clear off your debts easily and conveniently, and free yourself from the burden of EMIs at no extra expense.
Points to Keep in Mind while Opting for Prepayment of Home Loan
Though prepayment is a great option, below are a few things you must bear in mind:
- Tax Benefits: If you’ve taken a Home Loan you’re entitled to certain tax benefits. Make sure you carefully consider the tax benefits you’ll be losing out on while choosing to prepay your Home Loan.
- Future Requirement: It wouldn’t be wise to use up all your excess cash without saving some for emergency purposes. How much you should prepay from the available funds should be decided based on funds needed at the time of an emergency.
- The Cost of Prepayment: Certain lenders still do charge about 2%-4% of the loan amount as prepayment charges. Make sure you evaluate the cost you’ll be incurring while making a prepayment. Calculate the interest you’ll be saving by prepayment and weigh it against the prepayment charges.
- More than One Loan: If you have more than one loan, then choose to prepay the one with the higher rate of interest. As prepayment reduces the rate of interest, it’s a fairly safe bet.
What is an Investment?
Investment is the process of putting your money in any of these instruments — stock, bonds, fixed deposit, mutual funds, real estate, or any such vehicle.
Advantages of Investing Money
- The main advantage of investing money is that you’ll have a constant source of income without having to go to work. You can enjoy a decent standard of living.
- An investment allows you to have a financially sound future, especially after your retirement.
- Long-term investments work great for situations where you’ll need ready cash for your children and their expenses.
- If you choose your investment vehicle properly, you’ll be able to estimate your gains in advance and also be able to make safe bets without a good amount of research.
Points to Keep in Mind before Investing
- Check how financially sound you are. Can you make an investment at this point in time? Do you have enough funds kept aside for an emergency?
- Can you take a risk at this point of time? Not every investment vehicle is a risk-free one; some percentage of risk is always involved. Remember that you could lose some or all of your money if you aren’t careful with your investment.
- Make sure you invest in a combination of 2-3 vehicles; this procedure will keep you safe as the loss incurred in one vehicle can be compensated by profit made in another.
- Avoid falling for the so-called ‘special schemes’ and fraudulent offers. Take your time and make an informed decision.
Prepayment Vs Investment
How do you make this tough decision? Well, it’s easy. You’ll just have to compare the benefits of both and make an informed decision. First calculate the ROI you’ll be getting if you invest, then calculate the amount using home loan prepayment calculator, that you’ll be saving by prepaying the loan. Whichever way leaves you with a larger amount is essentially a better choice for you.
For example, let’s assume that you’re getting Rs.10,000 per annum by making an investment of Rs.1 lakh. But on the same amount you end up saving 15,000 on your interest if you use it for prepayment. So which method would you choose? Prepayment of course!
Both prepayment and investment have its own set of advantages and disadvantages. Evaluate both very carefully and choose the one which gives you better financial benefit.