A guide to home loan prepayment in India

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A guide to home loan prepayment in India

Sunita Vellapally Sunita Vellapally
von S Squared Architects Pvt Ltd. Modern
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After years of living in a small apartment or house, it’s only natural that one feels the need for a change and starts thinking about home loan prepayment so that a fresh loan can be taken for the new property. Whether it’s to satisfy the need for more space as the family grows or when the children ask for their own rooms, it’s best to be aware of the pros and cons of pre-closing the loan, especially since banks levy a penalty for prepayment of home loans.

Since one can get tax deductions on the principal amount repaid (up to INR 150,000) per year as well as on the home loan interest paid over a five-year period, it’s essential to calculate and verify whether it makes more sense to continue to repay the loan in installments or to incur the prepayment penalty on home loans and reinvest the money from selling the home into a SIP or a mutual fund.

It’s always best to consult a professional investment planner or a tax advisor before deciding whether the home loan prepayment makes financial sense. We’ve put together these tips to help homeowners get a basic idea on the various factors to consider before pre-closing a home loan.

What does home loan prepayment mean?

When a person avails a housing loan from a bank, it’s for a fixed tenure. In simple terms, home loan prepayment means that the borrower repays the loan before the tenure concludes. Prepayment can be made for a partial amount of the loan or the entire sum, depending on the availability of funds.

Why do homeowners opt for home loan prepayment?

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The most common reasons for pre-closing a home loan are:

The homeowner comes into funds and can prepay the loan so that he doesn’t incur additional interest as rates on home loans can be quite high. For example, if a home loan was taken for 80% of the cost of the property, then over a 10-year tenure, the principal and the interest payments could amount to the total cost of the property.

Often, if the loan is taken on a fixed rate and the market interest rates drop significantly, then the borrower might pre-close the loan to avail refinancing at the lower interest rate.

What are home loan prepayment advantages?

Although the interest paid over the tenure can be quite high, before prepayment of home loan, income tax benefits must be considered. One of the advantages of paying home loan EMIs is that the amount paid every year, subject to the upper limit set by the law, can be deducted from taxable income when computing the tax liability. Therefore, for homeowners who aren’t overly burdened by paying the interest and loan installments, it makes more sense to avoid home loan prepayment.

Are there any disadvantages of prepayment of home loans?

The main disadvantage of pre-closing is the home loan prepayment charges that the borrower needs to incur. All banks and financial companies levy a penalty between 3 and 5 per cent as a penalty for prepayment. Currently, following a directive by the Reserve Bank of India (RBI) in 2013, there’s no prepayment penalty on home loans with floating rates of interest.

Borrowers who availed loans with a fixed rate of interest might also be exempt from the penalty if the home loan prepayment rules in the agreement include a clause that exempts them from paying the penalty for pre-closing the loan before the tenure lapses.

What is the procedure to be followed for home loan prepayment?

In general, the following are the steps to be taken for prepaying a home loan:

  • Submit a written application to the bank informing them that you want to pre-close the home loan. Some banks will accept notification by email, whereas others might require a hard copy of the application to be filled and submitted at the bank.
  • Next, you should make a list of the original documents that were handed over to the bank at the time of submitting the original loan application, as these documents need to be returned to you. Usually, these include the sale deed, agreement between the builder and buyer, letter of possession, conveyance deed and the tripartite agreement between the seller, buyer and lender.
  • Additionally, you will need the loan agreement as well as identity proof and other documents that were submitted at the time of processing the loan.
  • Following this, the home loan prepayment amount needs to be remitted to the bank and an acknowledgement, which is signed and sealed, received from the bank.
  • Besides the payment acknowledgement, the bank also needs to issue a No Objection Certificate (NOC), which states that all dues have been cleared. Ensure that the NOC has all the essential details such as the borrower’s name and address, and the number of the home loan account.
  • After this, collect the original documents that were given to the bank at the time of applying for the loan (as listed in the second step). These should preferably be collected in person rather than couriered to prevent the risk of loss or misplacement.
  • The next step is to apply for the Encumbrance Certificate (EC) from the Registrar’s Office. The EC includes the details of all the financial transactions carried out for your property. It should also have the details of the home loan prepayment once it has been closed.
  • Homeowners who are looking to update their CIBIL score will have to wait for a while as it will be a few months before the CIBIL authority will update their records after receiving the details of the home loan prepayment from the bank. The advantage of a pre-closed loan is that it will improve your credit score.

What are some of the other factors to consider before pre-closing the home loan?

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Before deciding on prepaying a home loan, one should examine the clauses in the loan agreement to ensure that prepayment can be done without incurring a hefty penalty. Additionally, one should maintain a record of the number of installments paid, by saving bank statements that reflect the EMIs, in the case of online transfers. Photocopies of cheques or demand drafts should also be filed as proof of payment. A crucial point to think about is whether the financial burden of prepayment will weigh heavier on your finances than paying EMIs as there’s no point in cashing out all your savings for the home loan prepayment if it’s going to stress you out and keep you wondering what you will do in case of an emergency.

While payment of home loan installments and interest allow for tax deductions, from the point of growing one’s investment, it’s also advisable to look at other assets such as mutual funds, shares or gold. A home loan prepayment might seem like it reduces one’s financial burden, but if it involves diverting one’s savings or other investments towards the pre-closing, it could result in significant changes being made in one’s lifestyle. Before taking an impulsive decision to prepay, it’s best to consult a professional for advice, so that they can assess your finances and your investments and recommend whether the pre-closure is something you can manage without adding to your stress.

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