This question has many layers
Let’s understand them one by one
1. Most of the people prepay their housing loan in a hest because of their ingrained belief that loans are bad rather than on some financial rationale
2. In the first place they take out a housing loan because of another strong belief that ‘House is an asset and I MUST buy it at the earliest”
But then their belief about loans take over which propels them to prepay their housing loan without checking the financial logic.
Financial Rationale for Prepaying Housing Loan
Your Loan amount is too High vis-a-vis your assets (Solvency ratio) for e.g. you are running a loan of 1Cr and you have assets in the tune of 40 lakhs only (Real Estate, Mutual Funds, FD’s etc.) then it’s a red flag and an unhealthy solvency ratio.
EMI to Income Ratio
If your EMI (all loans put together) is too high in relation to your take home income then prepaying your loan makes sense. So for example -your take home income is 1 lac and you are paying an EMI of 50000/- then it makes sense to reduce your liability and free up your cash flow.
Normally the thumb rule is that your EMI preferably is not more than 35% of your take home income
Cost of Borrowing
It’s nothing but the rate of interest for your loan. It is important to check the opportunity cost VS Housing loan interest
Normally Housing loans are quite cheap.
For example currently the housing loan rate is in the range of 6.5-7.5 % and if we consider the tax benefit the interest cost would be 5-6 %;
So it is important to check the cost of borrowing before making the prepayment decision.
And if the pointers are in your favour then it makes sense to use your surplus money to create a robust investment portfolio rather than use those funds for Prepayment
This helps you in following way:
1. You can make efficient use of your resources by investing them more wisely.
2. You have surplus liquidity to cater to any other important goals.
3. You get tax benefit which can help you to save substantial income tax.
