Should you close your Home Loan?

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Study the trade-off between saving loan interest and earnings from investments

A home loan can help you buy a house early in life but it is also a burden which many people want to get rid of as soon as possible. Deciding whether to close a home loan or not is always a tough decision. There was a time when banks charged for prepayment, but this is no longer allowed. Still, there are other factors which should be considered before deciding to foreclose a home loan.

For some people, a loan is a very stressful thing. Even if they are comfortable paying the EMIs, they certainly aren't at peace mentally. If you fall in that category, then you should prepay your home loan. But be prepared to shell out a huge sum of money to foreclose the loan.

Home loan customers get caught in a dilemma whether to save on the interest paid to their bank or save the tax paid to the government. Home loans are eligible for certain tax benefits, including a deduction under Sec 80C for the principal repaid and deduction under Section 24 for the interest paid on the loan. The maximum deduction for the interest is `2 lakh per annum if the house is self occupied. If your total interest outgo is greater than the amount of tax deduction then it is wise to invest the surplus money in closing / reducing the home loan.

Of course, if the property has been rented out, the entire interest can be claimed as a tax deduction. In such cases, it is not advisable to foreclose the loan because the tax benefits will bring down the effective inter est rate.

Before you end a home loan, consider other outstanding loans that carry higher interest rate like personal loan, vehicle loan, education loan, etc. It always makes sense to close the high interest cost loans rather than a housing loan because the effective cost of a housing loan is far lower than those of other loans (see table).

If you still have surplus money after clos ing all your other high cost loans, go ahead and prepay your home loan. It is a trade-off between closing the housing loan or keeping it invested elsewhere to continue the tax benefit. In this scenario, you should compare the post-tax earning on your investment against your net cost of housing loan. As our calculations show, a loan at 9.5% effectively costs just 6.5% if you are in the 30% tax bracket. If your investments can fetch you a higher return, it makes sense to invest the money and continue with the housing loan. A lot of people prefer to park their money in fixed deposits.The fixed deposit that offers 7% will fetch a post-tax return of only 4.85%, which is lower than the 6.5% you can save by paying off the loan.

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