Because home purchase requires a large amount of money, very few people can buy one with the full down payment, and most homebuyers need to take out a home loan. There are some benefits to buying a home with a home loan as well – buyers save on rental costs by moving from a rented home to a home, and there are benefits in income tax on home loan interest and principal repayments as well.
Home loans are usually cheaper than other loans and the repayment periods usually vary between 15 and 20 years. Some financial institutions even offer home loans with a term of 30 years.
Even though home loan interest rates are lower, the longer the repayment period, the higher the total interest payment, even if the equivalent monthly rate (EMI) is lower.
For banks and financial institutions, home construction loans ensure a long-term stable income for 15 to 30 years.
However, should a borrower receive a lump sum or increase their regular income significantly during the long repayment period, should the additional money be used to repay the current home loan or otherwise invested in wealth creation?
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The decision to repay or invest should be made on a case-by-case basis.
When to repay
The decision to repay all or part of the loan amount can be critical in the following circumstances.
If there is uncertainty about future income due to a lack of career stability, it is better to reduce future liabilities by repaying the home loan early whenever the opportunity presents itself.
High share of EMI
If the EMI amount is very high compared to monthly income – e.g. over 40-50 percent of wages / earnings – it is better to use a lump sum to repay part of it to reduce the EMI amount.
When to invest
The decision to invest can replace the decision to repay based on the following factors.
Low interest rate
Since home loan interest rates are generally lower than most other loans, there is scope for higher returns on investment.
Because home loan terms are over 15 years, a borrower has the option to invest in long-term instruments like equity and get a much higher rate of return compared to the interest rate on a home loan.
Since there are tax benefits up to a limited amount of interest and the repayment of the home loan, it is better to continue on the repayment schedule to enjoy the benefits rather than making the repayment in one lump sum. In addition, a lump sum repayment would exceed the limit of the tax advantage in the year of the overpayment and limit the scope of future tax advantages.