When to opt for the possibility of prepaying your mortgage?
When the stock markets are doing well, interest rates are low, and you have excess money, you may wonder whether you should invest or prepay a home loan that you may have benefited from. .
According to industry estimates, the average mortgage repayment term is around eight years, which means that most borrowers prepay these loans.
It’s not surprising. When buying a home, the equivalent monthly payment (EMI) is an important part of the borrower’s payments. Most people stretch when buying a property.
However, a few years later, after increases and job changes, the EMI as a percentage of overall income declines. Most borrowers then begin to prepay their home loans with excess cash.
To decide whether to prepay your home loan, you will need to assess your current situation and determine whether it makes sense for you to prepay or continue with the loan. Since there is no simple answer to the question and expert opinions differ, you will need to answer this call at your own discretion.
If you look strictly at the numbers, there’s a rule of thumb that suggests that if you can earn better after-tax returns than the current interest rate on your home loan, don’t prepay. Instead, use that money to invest.
For example, mortgage loans from banks could currently be at a rate of 7-7.5%. Most planners expect after-tax returns of 9-10% for long-term stocks. As a rule of thumb, starting a long-term systematic investment plan (SIP) turns out to be a better option because the returns on investment are about two percentage points higher than the mortgage interest rate.
âNo one can predict the performance of the stock market. Current stock valuations may be stretched, and over the next several years, returns may remain modest. In such a case, the borrower may think it was a better option to prepay than to invest in stocks, âsaid Arnav Pandya, founder of Moneyeduschool, an Ahmedabad-based financial education initiative.
Therefore, don’t just rely on the rule of thumb.
Before you decide to prepay your home loan, make sure your basics are covered. You should have an emergency fund that covers 6 to 12 months of expenses. In addition, there should be adequate life and health insurance coverage.
âThe individual must also check whether he is saving enough to reach his goals. If individuals are behind in their goals, it is best to increase monthly investments first, âPandya said.
A better strategy is to use the profits from your investments to prepay your home loan rather than a bonus or extra money you’ve saved on your income. âThe individual can use part of the profits to prepay the mortgage instead of using the capital. Whether individuals use 10% or 50% of the profits is entirely up to them. The idea is not to use capital, âexplains Kartik Jhaveri, director of Transcend Consultants.
Some experts believe that an individual should not pay up front if the tax benefits available on a home loan represent a significant portion of income and have time to retire. A person stands up â¹Tax benefit of 1.5 lakh on the main part of the mortgage and up to â¹2 lakh on the interest part.
âIf the tax savings are a big part of income, it’s best not to pay up front. The extra money available each year will provide liquidity, âsaid Malhar Majumder, Kolkata-based distributor and mutual fund partner, Positive Vibes.
He added: “It would make sense to only prepay when retirement is approaching and the person wants to pay off all the debts.”
Also, before making a decision, assess if you have significant expenses a few months later.
According to financial planners, people often prepay their loans with additional cash and then take out a loan or swipe a credit card to meet a hefty expense a few months later.
First assess your situation, then decide whether you should prepay or invest the excess cash.
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