Is prepaying your home loan a smart financial move? Here’s what you need to know

Financial prudence suggests eliminating liabilities as soon as possible, and prepaying your home loan can be a wise move if you have surplus funds. However, the decision to prepay or retain a home loan also depends on the tax regime you choose.

Prepayment is particularly beneficial for those nearing retirement, helping them clear liabilities before their income stream decreases. In addition to reducing the overall interest burden, prepayment can shorten the loan tenure, improve credit scores, and provide greater financial security by lowering monthly obligations, says Raoul Kapoor, Co-CEO of Andromeda Sales and Distribution.

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“Carrying a large housing loan can become a psychological burden for many people. The constant worry about the debt can overshadow your financial freedom, and that’s why some choose to prepay as soon as they have the means to do so,” says B. Srinivasan, director and founder, Shree Sidvin Investment Advisors.

Pre-Payment Helps Reduce EMIs

When a borrower prepays a home loan, the biggest advantage is the reduction in total interest outgo. Since interest is calculated on the outstanding principal, making lump sum payments lowers the outstanding amount on which interest accrues.

For example, consider a ₹50 lakh home loan at a 9% interest rate for a tenure of 20 years. Now, if the borrower prepays ₹5 lakh after five years, the remaining loan balance decreases to approximately ₹39.35 lakh. As a result, the interest component of future EMIs reduces.

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“Depending on the bank’s policy, the borrower can either opt to reduce the EMI amount or shorten the loan tenure,” says Kapoor.

If the borrower chooses to keep the EMI unchanged, the loan tenure reduces from 20 years to around 15 years, ultimately saving approximately ₹16.30 lakh in interest payments.

Loan Comparison Table

Does Choice Of Tax Regime Play A Role?

The choice between prepaying and retaining a home loan also depends on the tax regime one opts for.

Under the old tax regime, borrowers can claim deductions on both the principal and interest payments. Section 80C allows a deduction of up to Rs1.5 lakh on principal repayment, while Section 24(b) permits a deduction of up to ₹2 lakh on interest paid. These deductions effectively lower the tax liability, making it financially prudent to continue the loan in many cases instead of prepaying.

If a borrower falls under the highest tax bracket and is utilizing the full deduction limit, the tax savings can be significant.

“For instance, if someone pays ₹2 lakh as home loan interest annually and falls in the 31.2% (including cess) tax bracket, the effective tax saving would be ₹62,400. In such cases, the net cost of the loan reduces, making prepayment less urgent,” says Kapoor.

However, if the borrower is not fully utilizing the deductions or falls under a lower tax bracket, prepayment could be a more financially logical step.

Under the new tax regime, these deductions are not available. In such cases, prepaying the loan can be a more attractive option as there are no tax incentives to keep it running.

But one should remember that even under the old tax regime, for self-occupied properties, tax benefits on home loan interest are capped at ₹2 lakh per year. If you pay more in interest, you can’t claim tax relief for the excess. So there is always a scope to repay if you have a higher loan amount.

“If you receive a lump sum or extra money, use it to prepay your housing loan, then take the saved EMI and invest it in SIPs. This strategy helps build wealth over time while reducing your loan liability,” says Srinivasan. It’s a disciplined approach to enhancing both your savings and assets.

Anagh Pal is a personal finance expert who writes on real estate, tax, insurance, mutual funds and other topics