Is It a Good Idea to Pay Off Your Home Loan Early?

Suppose you took a huge loan for your house and every month; part of your income went to pay it back. What if, after a while, you received some extra cash and wanted to pay off a large chunk of that loan in advance? Technically speaking, that is what is known as "prepayment." But is this always the best option? Let's find out what prepayment in home loans is and whether it's good or bad for you.

What is Home Loan Prepayment? 

Prepayment basically refers to the payment of greater amounts towards your loan when compared to your regular monthly installments. You can pay it off within a few years instead of keeping on paying for years. This may sound a pretty luring idea because it might save you money, but like any other thing in life, it has its pros and cons.

Advantages (Pros) of Prepayment in Home Loans

Following is some of the pros of home loans.

1. Saves Interest Money

You have to pay extra money, referred to as interest, with the money you borrow for your house. To be precise, it's a levy on borrowing. The longer it takes you to return the loan amount, the more interest you are forced to pay. By prepaying, you save on the total interest since you are repaying faster.

2. Shortens Your Loan Period

Typically, a home loan could take 10, 20, or even 30 years to pay back. In that case, by making a prepayment, you are paying back a portion of the loan in advance before the scheduled period. This would mean finishing your loan payments sooner and an earlier release from that monthly burden.

3. Gives a Sense of Relief

Paying off loans in advance is always a peace of mind. It feels nice to have fewer debts hanging over your head, especially if you foresee future income or a financial crunch.

4. More Savings for the Future

Once you pay the loan, that money is used for other purposes. It may be to save for your kids' education, a family vacation, or even to buy another property. The more you get rid of this loan, the more money you can save for your future.

5. No More Worrying About Interest Rate Changes

The interest rate for home loans varies with the economy. When it increases, you are certain to be paying more each month. Prepaying thus saves you from the risk of such changes affecting your loan.

Disadvantages (Cons) of Prepayment in Home Loans

Following are some of the disadvantages of prepayment of home loan:

1. Prepayment Penalties

Some banks may have a penalty when you pay off your loan before the period has expired. This is referred to as a prepayment penalty. This is something you would want to ask your bank if they have such policies. If the penalty amount to high, it might not be worth it to prepay.

2. Losing Tax Benefits

Now, in Nepal, there are tax benefits available from interest payable on a home loan. The moment you prepay and bring down your loan amount, there is some loss in these benefits. It's like giving up on some tax savings.

3. Reduces Liquid Cash

Prepaying on a loan simply means paying the bank from your savings. This amount given to the bank will not be utilized in cases of emergencies or other major needs. Having liquid cash is what helps during unfortunate situations.

4. May Miss Out on a Better Investment Opportunity

Instead of prepaying your loan, you could earn a higher return from investing money elsewhere, such as in stocks or other businesses. More often than not, these types of investments can give you more profit than the interest you will save by prepaying on the loan.

5. Opportunity Cost

In this case, by prepaying the loan with your surplus money, you are giving up either investing or spending the money elsewhere. It is more commonly known as opportunity cost. Perhaps you planned on starting a small business venture, traveling, or buying your family something that was needed. Once you have given it as prepayment, it is lost in that context.

Conclusion: Should You Prepay Your Home Loan?

There are a few pros and cons of paying off a home loan in advance. You stand to gain by saving on interest, completing the loan more quickly, and even having peace of mind. But if you prepay the entire loan, all your savings will be depleted and, most importantly, you will lose out on any tax benefits on interest payment. Investment options will also become scarce. It is best to discuss everything with your bank or financial advisor before you begin.

FAQs 

Frequently asked question about home loan and prepayment of home loans.

1. What is the prepayment of a home loan? 

Prepayment refers to an amount in excess that you pay towards the home loan before the scheduled time.

2. Will it always be a good idea to prepay my home loan?

It depends. Yes, it will save you money on interest, but possibly at the cost of losing some tax benefits or incurring penalties.

3. Do all banks allow prepayment?

Mostly yes, but some have a penalty attached to prepayment. So it would be advisable to check with your bank.

4. How much can I prepay?

You are generally free to prepay any amount, but certain banks may have restrictions. The terms of your loan agreement should always be checked.

5. Will I get any tax benefit after prepaying my home loan?

You may lose certain tax benefits on interest on a home loan in case of prepayment, especially if you close the loan prematurely.

6. What if I prepay my entire loan?

If you pay off the entire loan, you will be free from monthly payments, but you may lose tax benefits and may have to pay a penalty.

7. Should I prepay or invest my money elsewhere?

Sometimes, investing gives better returns than the interest you save by prepaying. Always best to consult with a financial expert before making a decision.

8. Can I make small prepayments from time to time?

Yes, many people make small prepayments from time to time so that the loan burden can be reduced without completely draining their savings.

9. What are prepayment penalties?

These are fees charged by banks for paying off your loan early. Not all banks charge this, so check with your lender.

10. Is prepaying my loan good for my credit score?

Prepaying can show that you are financially responsible, but it doesn't have a huge impact on your credit score.