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Saturday, October 18, 2008

Home loans - Should you prepay or stay with higher EMIs?

Home loan borrowers are in a dilemma at this juncture, whether to continue repaying EMIs at the same level, to increase the amount, or make part-payment to reduce the loan period.

A mere half percent increase in home loan lending rates stretches the repayment period by two-and-a-half years.

In such a scenario, is it appropriate to switch over from one institution to another to take advantage of even marginal differences in interest rates? But what if the rates change yet again once you have made that switch?

These are the kind of questions that haunt home loan borrowers who have been caught in the soaring interest rate regime, with their worries being doubled by the steadily dropping disposable incomes. What is the way out of this impasse?

Should you prepay or stay with higher EMIs?
“At the present rate of 11.50 percent, borrowers end up repaying only 27 percent of their principal amount by the end of seven years and 47 percent by the end of 10 years, that is only if the interest rate continues to remain at the same level,” says Ramesh Kumar, a chartered accountant.

The hike of an additional one percent would result in repayment of only 25 percent of the principal amount by the end of seven years and 45 percent by the end of 10 years.

Read: Tips to lower your Home Loan EMI Burden

According to bank officials, if the intention of a home loan borrower is to maintain the EMI at the same level, the best option would be to make a prepayment as there is no charge involved.

Also, while it is wise to negotiate on the best interest rate, it’s not advisable to switch for only a marginal difference. A two percent charge plus taxes is levied on switchovers. Those in the age group of 25-30 years prefer to stretch the repayment period and maintain the EMI at the same level.
Whereas those in the 45-55 age bracket prefer to confine their repayment within the retirement age as part-payments bring down the loan tenure substantially.

One option is to increase the EMI but for those who cannot afford it, the only choice is to make part-payment during the tenure of the loan.

A few institutions advice that retaining lump sum payment in deposits and continuing EMI at an enhanced level would enable a borrower to use the money in the event of exigencies.

At least 70 percent of the home loan borrowers resort to this route, say bank sources. And 10-15 percent prefer to prolong the repayment period.

There are others who suggest that people should take advantage of the terminal benefits like provident fund as they fetch a lesser interest rate these days. They can use the low-cost loan to service the highcost loan and bring down the repayment period.

But even financial institutions do not subscribe to the practice of using one loan to service the other. Consultants also advise consolidation of assets to bring down the home loan repayment burden through phased repayment.

According to Ramesh Kumar, “If the loan-to-cost ratio (LCR) is low, it is always better to service the enhanced EMI in case of any increase in interest rates since the affordability is better when they take lesser quantum of loan.”

Borrowers should not overstretch just because 85 percent of the property value is available as home loan. “It’s better to sell existing property and use a home loan for the rest of the money as against holding smaller units in addition to buying a new one,” he adds.

A significant development is that unlike other countries, property prices have appreciated over the years in India. One can avail a mortgage loan at competitive rates. Reverse mortgage has been introduced to help senior citizens in the absence of social security benefits.

One can take a loan against future rent receivable and plough back the money into more profitable avenues. So, having a property in your name is a lifelong security that’s definitely worth investing in.

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