Having a roof above
one’s head is a recurring dream among us. Most don’t find comfort and peace
they seek, in a rental home, however good it may actually be. The primary
reason cited is that we may be evicted from this home, anytime. That hangs like
a Damocles sword over the head and many find this most disconcerting. The
second is that the home may lack comprehensive facilities, which the landlord
may not provide. Thirdly, there could be restrictions about the property usage,
which can be stifling.
All these drive
people to conclude that owning a home is the silver bullet to these problems.
Since this belief is widespread, there is a huge demand countrywide for homes.
With incomes surging & demand for homes robust, property prices have
floated up, up and away. In many parts of the country, it has reached
stratospheric proportions.
The upshot is that
most people who buy properties take huge loans to give shape to their dreams.
EMIs are hence an integral part of most people’s lives now. And these EMIs
would go on for long – 20 years, on an average.
There is another
quirk that afflicts our people. We have a tradition of eschewing loans.
Virtually in every indian language there would be a wisecrack espousing the
cause of living debt-free. Hence, being debt-free is an article of faith among
most, due to which people are not comfortable having loans. They would like to
prepay that as soon as feasible.
Should you prepay
your home loan or is it advantageous to keep it? If you need to prepay, when
and how much should you prepay? Let us discuss these.
The first aspect to
consider is the stability of income of the loan taker. If that is in question,
servicing an EMI over the years can pose serious problems. Self-employed can
find the income varying a great deal – surging at certain points and dwindling
at others. Even among those employed, some employments are more stable than
others. In such situations, every endeavor should be made to reduce the loan
amount, at every possible point, irrespective of the tax-savings or other
considerations. Bonus/ Exgratia or any other inflow can be used to retire
outstanding loans. This will bring down the exposed loans.
The second
situation where it would be suggested to reduce the loan would be, when the
home loan EMI as a percentage of take-home pay is beyond 40%. When the amount
is higher than this, it exerts a lot of pressure on one’s cashflows, which is
not healthy. Bringing the EMI amount to 40% of the take-home income or less is
desirable. It is even more necessary if there are other EMIs for vehicle loans,
personal loans to consider. If the EMI amount on the home loan comes below this
40% threshold and does not pose cashflow problems, it can be continued subject
to effectively low interest rates, which is the next aspect to be considered.
The third aspect to
consider is the effective interest rate that one is paying. In case of home
loans, the principal portion comes under Sec 80C and the interest portion comes
under Sec 24. After accounting for all the benefits, if one were to calculate
the net cost of loan and that interest cost is above what one can earn by
investments in a fixed income instrument, then pre-paying the loan is
desirable. For instance, if the net interest cost amounts to 9.75% and the
post-tax returns from any fixed income instrument is at best only 8.2%, then it
is preferable to prepay any extra amount one has.
The fourth aspect
to consider is the tenure. If due to interest rate increase, the tenure extends
beyond the superannuation age, it is a red flag. It is desirable to bring the
tenure down so that a person can pay-off the loans before he retires. It is
generally desirable to finish the loan several years prior to retirement, as a
safe practice.
Home loan is a
comparatively low-cost loan. If one wants to access loans for others, say a
vehicle, it may make sense to instead keep the home loan intact instead of
prepaying it and use the cash to reduce the loan to be taken for a vehicle.
This will reduce the overall costs. For instance, if one wants to buy a Rs.4.5
Lakhs car in 2 years, and one also has a home loan of Rs.25 Lakhs with an
effective interest rate of 9.75%, it may be a good idea to not prepay the home
loans in the next two years. A better idea would be to invest the amount that
could have been used for such pre-payments and reduce the vehicle loan to be
taken. Vehicle loans would be between 2-4% more than the home loan rates and
they offer no tax breaks for salaried individuals.
After these considerations,
one could decide to keep the home loan or part-pay based on the various points
discussed. One could also decide to tweak the EMI. One could keep the EMI high,
even though prepayment has been done, to bring down the tenure. Or could allow
the EMI to come down as the loan exposure amount goes down, if the tenure does
not pose a problem.
The main aspect to
keep in mind is that one cannot get obsessed with closing the home loan. Proper
consideration needs to be given and one needs to act on the merits of the case.
Article by
Suresh Sadagopan, Founder, www.ladder7.co.in Published in Business Standard on 22/7/2012
No comments:
Post a Comment