The Reserve Bank of India (RBI) started elevating the repo rate (in May 2022), which has led the property loan interest rates to increase substantially. The RBI has increased the rate six times since then.
Experts anticipate that current bank rates for mortgages will rise to 9.25 percent. On February 8, 2023, rates increased by 25 basis points, the most recent increase. In this situation, the borrower has three options:
- Extending the duration of the loan
- Increasing monthly payments
- Paying off the debt early
Conditions When Loan Prepay Can Be Advantageous
Consider the advantages and disadvantages of paying off your mortgage early before you decide. You may want to consider paying off your mortgage early:
When you have extra funds in low-yielding fixed-income plans
The interest rate on a mortgage loan is more than the returns on fixed-income instruments such as fixed deposits. If you intend to pay off your mortgage early, it is best to liquidate any excess assets you may have in plans with returns lower than the loan interest.
Before using this money, you should ensure a backup plan for achieving any financial objectives you may have established for emergencies or other reasons. In addition, you should not sell long-term assets, such as stock mutual funds, that may provide returns that exceed your mortgage’s interest rate. This might hinder your ability to save money, which is the core objective of loan payback.
If your yearly interest rate is greater
Due to its many tax advantages, a home loan might save you a substantial amount on taxes. Interest paid during a fiscal year may be deducted up to ₹ 2 lakhs under Section 24(b) of the Income Tax Act of 1961. Only interest paid on an owner-occupied residence is eligible for the maximum deduction of ₹ 2 lakhs. There is also no upper restriction on the number of properties that may be leased.
If the after-tax returns on your assets are greater than the after-tax returns on your mortgage, it may be advantageous to keep your mortgage open and not pay it off early.
Therefore, it is sensible to pay off your house loan early if your interest amount exceeds ₹ 2 lakhs in interest.
If you don’t utilize the entire Section 80C deductions
Section 80(C) of the IT Act allows you to deduct up to ₹ 1.5 lakhs from the principal amount you pay. If the property is sold within 5 years of purchase, the law considers it as income for the year you sell. If you want to avail yourself of the tax advantages of a mortgage, you may choose to make on-time payments.
If your payment is below ₹ 1.5 lakhs for the repayment of the principal amount in the home loan and you have nothing else that qualifies for a tax benefit under this provision, you should choose the prepayment option.
Let’s assume that ₹ 80k of your monthly housing loan EMIs go towards principal repayment. Your entire 80C investments, including life insurance payments, child tuition, fixed deposits with a 5-year lock-in, etc., cannot exceed ₹ 50,000. To maximize deductions under Section 80C, it appears appropriate to make an annual housing loan payment of ₹ 20,000 in this instance.
When mortgage tax exemptions are not required
If you don’t need further tax incentives and have extra cash, you may want to consider paying off your mortgage early if you already have several tax strategies in place.
Conclusion
Even while it may be tempting to pay off debt as fast as possible, particularly when the current bank rate is rising, it is essential to do a cost-benefit analysis that considers tax advantages and other investment options. To maximize tax benefits, it is better to leave a portion of the mortgage unpaid. On the other hand, if you don’t want the tax advantages of a house loan and don’t know of any high-return investments, you should pay off the mortgage as quickly as feasible.
Don’t forget to keep note of all the costs associated with early mortgage repayment. If you have a variable-rate mortgage, banks are not permitted to apply a prepayment penalty. However, prepayment penalties on loans with a fixed interest rate may range from 2% to 4%, even on an online Home loan.