Are you considering prepaying your home loan to save interest and become debt-free sooner? While prepaying a home loan may sound like a smart move, there may be better decisions for your financial situation. Some scenarios exist when prepaying your home loan can hurt your finances more than help them.
This blog will go over a few reasons why you should not prepay your home loan and how to decide whether prepaying your home loan is right for you. Let’s get started!
Reason 1: You have a high-interest debt
One of the most common reasons people prepay their home loan is to save interest. However, before you rush to prepay your home loan, you should first check if you have any other debt with a higher interest rate than your home loan, such as credit card debt, personal loan, car loan, etc.
If you do, paying off your high-interest debt first makes more sense, as it will save you more money in the long run. For example, suppose you have a home loan of Rs 50 lakh at an 8% interest rate and a credit card debt of Rs. 1 lakh at a 24% interest rate. If you prepay Rs. 1 lakh towards your home loan, you will save Rs 8,000 in interest annually. But if you use the same amount to clear your credit card due, you will save Rs 24,000 in interest per year. That’s a difference of Rs. 16,000!
Therefore, you should prioritize clearing your high-interest debt before prepaying your home loan, as it will reduce your overall interest burden and free up more cash flow for other purposes. You can employ a home loan prepayment calculator to get a better idea.
Reason 2: You have a low or uncertain income
When you prepay your home loan after evaluating with a mortgage loan EMI calculator, you are essentially locking up your money in an illiquid asset, which means you cannot access it quickly in an emergency or an unexpected expense. For example, suppose you have a home loan of Rs 50 lakhs at an 8% interest rate, and you prepay Rs. 10 lakhs towards it. Your EMI will reduce from Rs. 40,935 to Rs. 32,748, saving you Rs. 8,187 per month. But what if you lose your job, face a medical emergency, or need to repair your car? You cannot use the Rs. 10 lakhs you have prepaid, and you may have to borrow money at a higher interest rate to meet your needs.
Therefore, keep a sufficient emergency fund and a stable income before prepaying your home loan, as it will ensure that you have enough liquidity and cash flow to deal with any unforeseen situations.
Reason 3: You have a long-term investment goal
Another reason people prepay their home loan is to achieve their long-term investment goal, such as saving for retirement, children’s education, or buying another property. However, this can also be counterproductive if you can invest your money in other assets that can generate greater returns than the interest rate of your home loan.
When you prepay your home loan, you essentially give up the opportunity to invest your money in other avenues that can grow your wealth faster and help you arrive at your goal sooner. For example, suppose you have a home loan of Rs 50 lakhs at an 8% interest rate, and you prepay Rs. 10 lakhs towards it. You will save Rs. 8 lakhs in interest over 20 years. But if you invest the same amount in a mutual fund that gives you a 12% return, you will earn Rs. 32 lakhs in the same period. That’s a difference of Rs. 24 lakhs!
Conclusion
Prepaying your home loan can be a good or a critical decision, depending on your financial situation, goals, and preferences. Some benefits of prepaying your home loan include lower interest costs, shorter loan tenure, better credit scores, and financial freedom. But there are also some drawbacks of prepaying your home loan, such as prepayment penalty, liquidity loss, reduced tax benefit, and opportunity cost.