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| Is it worth prepaying home loan? |
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Rattan Chugh
ExpressMoney
With Interest Rates Increasing, Many People Are Considering Prepaying Their Home Loans. Rattan Chugh Lays Down Some Ground Rules
Interest rates on home loans have consistently been on an upward trend in the last couple of years.
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Every time the bank intimates an increase in the interest rate, one wonders whether the raise has gone a bit too far and is it time to retire the loan.
The key to decide on the pre-payment of the loan is whether your own funds can fetch you better returns than the interest that you are paying to the bank. The crucial element to the above equation is the impact of income tax both on your returns and the rebate available on interest payment on home loans.
Under the Income Tax Act you can get deduction against the interest payment on home loans up to Rs. 1,50,000. This means that if you are on the highest slab of rate of personal income tax, you can save up to Rs. 50,490. The rate of tax on your returns depends on the asset class that you choose and the tenure of the investment.
Capital gain tax on equity based investments is nil on investments for more than a year and is at the rate of 10% on investments for less than a year. Capital gain tax on debt based investments is at the rate of 10% for more than a year and at the rate of personal income tax applicable to you on investments less than a year.
The table below shows the target interest rate that you need to earn to break even. The current rate of interest on home loans is around 10.5 %. Assuming that you have a loan outstanding of Rs. 20 lakh, annual interest payment to the bank will add up to Rs. 2.1 lakh and you will be eligible for a tax rebate of Rs. 50,490. Therefore, your investments should at least earn you Rs. 1,59,510 post tax, which is a return of 8%. To keep the illustration simple, I have not taken reducing balance in to account .
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Loan Amount |
Interest paid (A) |
Tax rebate (B) |
Net Outflow (C=A-B) |
% return required |
1,000,000 |
1,05,000 |
35,343 |
69,657 |
6.97 |
1,500,000 |
1,57,500 |
50,490 |
1,07,010 |
7.13 |
2,000,000 |
2,10,000 |
50,490 |
1,59,510 |
7.98 |
2,500,000 |
2,62,500 |
50,490 |
2,12,010 |
8.48 |
3,000,000 |
3,15,000 |
50,490 |
2,64,510 |
8.82 |
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| Note: All amounts are in Rupees |
| Rate of interest on home loan taken at 10.5% |
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There are various asset classes to choose from, to make your investments.
As per the statistics published by the Reserve Bank of India, there is a strong bias amongst the Indian households towards putting their money into bank deposits.
These deposits are currently offering 8 to 9% return but are taxable at the rate of personal income tax which makes the effective rate of return 5 to 6%.
Holding on to the loan while keeping your savings in bank deposits is certainly not a good idea, unless you have a need of liquidity in the near term.
Mutual funds are periodically launching fixed maturity products that are currently giving a yield of around 9%, which after long term capital gain tax comes to around 8%.
These products further invest in ‘AAA’ rated fixed income securities, maturing normally in line with the duration of the scheme.
Then, there is an option to invest in equities either directly or through Mutual funds (MFs). Although equities are higher risk assets, they tend to give a higher return over the long term.
You should develop an appropriate mix of fixed income and equity in your portfolio so as to maximize your projected returns and at the same time manage the risk within your level of tolerance.
The table below shows the amount you can save annually by retaining the loan based on different rate of returns: |
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Rate of return |
8% |
10% |
12% |
15% |
Loan Amount |
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1,000,000 |
1,367 |
19,123 |
36,879 |
63,513 |
1,500,000 |
-474 |
26,160 |
52,794 |
92,745 |
2,000,000 |
-17,462 |
18,050 |
53,562 |
1,06,830 |
2,500,000 |
-34,450 |
9,940 |
54,330 |
1,20,915 |
3,000,000 |
-51,438 |
1,830 |
55,098 |
1,35,000 |
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Note: All amounts are in Rupees |
| Rate of tax on return taken at flat 11.22% |
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The other point to note here is that even with the current rate of interest, Home loans are the cheapest loans that you can get. If you need liquidity or expect a big expense coming your way in near future, it makes sense to retain the loan.
Lastly, do read the fine print of your loan deal before taking the decision. A lot of home loans have pre-payment charges of around 2% that need to be taken into account. |
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The writer is CEO, Cornerstone Wealth Management
rattan.chugh@cstone.in
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