Five Reasons Why You Should Not Prepay Home Loan

Five Reasons Why You Should Not Prepay Home Loan

Once, I asked one of my colleagues how he will spend his performance bonus this year. He stared at me for a while and seemed that why am I asking this nonsense question which has an obvious answer. Yes, he has an outstanding home loan of approx. of Rs. 20 lakhs. For him, prepay home loan is the obvious answer. But, is he right in taking the decision? We will try to figure out the answer.

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The decision of prepay home loan principal is more of an emotional decision than a logical decision. Some persons are not comfortable with having any burden of a loan on them. So whenever they take a loan for some requirement, they always try to get rid of the loan.

Now, you think of opportunity cost of prepaying the home loan. Opportunity cost is the loss of money due to the pre-payment of the home loan rather than investing in some other product. This investment will help you to grow your corpus for brighter future.

A friend of mine has paid Rs 1 lakh to the home loan account last year. The interest of the outstanding home loan is 9.5%. Hence, instead of paying into the loan account, he should invest the money in equity diversified fund which can fetch more than 9.5% interest easily. But he has listened to his mind which call for to be debt free even if it is less.


If you are not bothered about the home loan burden and you can think logically, you can continue with your home loan EMI. Home loan interest up to 2 lakhs is deducted from the income and home loan principal up to 1.5 lakhs can be shown in 80C of income tax act. You can invest in some other options to get the tax benefit for 80C but you cannot get the benefit of 2 lakhs as interest. So, if your EMI consists of less than Rs 2 lakhs as interest component, you can continue with the loan.

Suppose you have an outstanding loan of 50 lakhs and the interest rate is 9.5% per annum. So the interest is Rs 4.75 lakh. After deduction of Rs 2 lakhs, the effective interest amount is Rs 2.75 lakhs and the effective interest will come down to 8.3% (Assuming you are in 30% tax bracket)

If your interest is less than Rs 2 lakhs a year, it would not be a good strategy to prepay the loan, as you are not utilizing the full benefit of interest deduction from the income. Your outstanding home loan is Rs 20 Lakhs, the interest is 1.9 lakhs. If you are in 30% tax bracket, net interest is Rs 1.33 lakh (Substracting 30% of 1.9 Lakh i.e. Rs 57,000). The effective interest is coming 6.65%.

Even if you invest this money into PPF or sukanya samriddhi account, you will get more return.  If you are ready to take the risk and you have longer time duration with you, you can invest the corpus into equity market through direct buying of stocks or through the mutual fund.

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Tax Benefit:

The decision to prepay home loan is equally dependent on the impact of such repayment on your eligibility to claim interest deduction under Section 24(b). In case the property is self- occupied, you are allowed deduction only up to Rs. 1.50 lakh of interest.

So in case any part prepayment does not bring down the amount of interest below 1.50 lacs, it will not have any impact on your tax liability. However in case the property is let out, the decision would be different as entire interest payment is tax deductible. So evaluate the tax impact due to the reduction in interest payment.

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Funds Requirement:

Take the decision of prepay home loan after considering the other liabilities. If you don’t have contingency amount, you should first save for that. Contingency amount can take care of yourself in a case of an emergency such as medical, joblessness etc.

Then take the step to buy term insurance and health insurance. You can use this extra money to complete these must have insurances. Even more than that, if you require the lump sum amount to meet other liabilities like personal loan, vehicle loan etc., prioritize that requirement because the home loan has the lowest interest rate among all the loans available in the financial market.

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Evaluation of other Alternatives

While evaluating the option of prepaying the home loan, please consider the alternative options available for investing such as bonds, equity mutual funds etc. If you are invested in the fund for longer term i.e. at least 5-10 years you will get more return.

Generally, equity mutual funds are giving better return with respect to the home loan interest rate if you stay invested for a longer term (at least 3-5 years) in the equity market. Investing in the mutual fund is getting easy day by day. if you want to know how, read how you can start mutual fund online in three ways.

Also Read: Six Leading Equity Mutual Funds to Invest in 2017

So, there are many factors which are influencing the fact of prepaying the home loan. If you are logical and burden of loan does not hamper your peace of mind, you can continue with the loan and invest the surplus amount to another instrument.

Or if you think, my home should be debt free or I cannot take the burden of such a huge loan, you can take the decision of prepaying the home loan.

If you feel something different, don’t hesitate to comment on the comment box.

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  1. Ashish March 20, 2017
    • Suman Kumar Gayen March 20, 2017
  2. vivek sardana March 28, 2017
    • Suman Kumar Gayen March 28, 2017

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