To pre-pay or not to pre-pay my housing loan- that is the question!

Most of us who have borrowed money to buy a house are often plagued with the question - should we pay it off early? Or just keep plodding along till the term ends? There are passionate proponents for both sides. Confused?

There are no right or wrong answers. Each of us is unique and even if logic says you may make more money if you don't pre-pay, it may cause you stress to have a loan hanging over your head.

Perhaps, this step-by-step thought process will bring some clarity.

Before you start just pop your Relationship Manager a mail, and keep this information handy.

• Are there any pre-payment penalties on my loan?
• What is the current Interest Rate on my loan?
• What is the tenure left on the loan? 
• If the loan is not pre-paid, by the end of the term, what will the property actually cost you?

Ready?

Step 1 :  EMI Vs Income

Is your Equated Monthly Installment (EMI)  more than 20-30% of your monthly income? Yes?  Proceed to the next step. No? you can still go through the next steps to clarify your thinking.

Reducing the EMI to 25% of monthly expenses worked well for one of my clients who had to take a salary cut during the pandemic. By tightening other expenses he was able to keep paying the EMI.                               

Step 2 : Time left on Loan

Do you have less than 10 years left on your loan?  If yes, proceed to the next step!

P.S. If you are young and have few responsibilities you can start pre-paying after 5-6 years after starting the loan.

 A client in Ahmedabad would have spent 78 lacs on a house that was worth 36 lacs is she had paid interest for the entire term. She pre-paid after 6 years and brought the overall cost down substantially!

Step 3 : Check your Asset Allocation

Take a look at the financial assets you hold. Already heavy on equity vs your model?   Are the markets up? If yes, you could consider using some of your equity profits to pre-pay the loan. But before you decide, proceed to the next step!

 A couple checked their asset allocation on 5th April 2021. Their model indicated a ratio of 30: 70 (Debt to Equity). Actual ratio 15: 85! 

They sold some of their equity and brought their EMI to 10% of their expenses. On 15th Apr 2021, the wife received an email that her company will shut down on 1st June 2021. She is highly qualified and will definitely get another job. Thankfully, since their EMI is now so much lower, and they have 9 months of household expenses in emergency funds, they are secure. And as we speak, markets have corrected!

Step 4 : Loan Rate Vs Investment Return

Be honest with yourself when you answer these questions. Are you conservative by nature? Do you prefer FD's & Interest earning products? What are the current net of tax returns on the products you normally invest in? 

If your answer is that  you would probably make less on the products you invest in, proceed to the next step!

A lady was paying Rs. 78000 p.m. as EMI @ 9.1%. The rest of her savings were being away in bank fixed deposits which were earning her 6.8% net of tax (she was always worried about losing her job). We used some of her bonus to pre-pay her loan over a period of time. Today she is debt free and she sleeps in peace. 

 
Step 5  : A few more checks before you pre-pay!

• Is your Current income stable?
• So you have 9-12 months Emergency Funds ?
• Any big goals or events coming up? for e.g. a baby on the way?
• Have you got a thumbs up from your CA & financial advisor?

Go for it!

Life is uncertain. Carefully calculate your monthly expenses. Keep a min of 9 months in ultra safe investments like liquid funds and bank deposits. Most importantly, before you actually pre-pay consult your CA and advisor for tax write-offs/other benefits. 

A client who ran his own flourishing business was confident that he didn't need to worry about emergency money. Due to the lockdown all his outstanding payments were delayed and he had to borrow from his dad to pay his EMI's.

A word of caution - these are only pointers. Please consult professionals before executing.