Though it is advisable to increase your equated monthly installment to reduce your home loan tenure and help you repay your loan faster, you still need to keep it at comfortably manageable levels to be on the safer side.
Why is this the case you may wonder. A valid argument for you is, I would rather save on the huge interest cost by managing to pay a higher EMI, rather than pay a lesser EMI and face a long loan tenure.
There is a solution to get the best out of both the situations. The solution is to prepay.
You need not worry about the long tenure as you can prepay the amount that is around 3-4 times your EMI periodically like once a quarter or when your year end bonus comes through.
This will effectively help you manage your loan and consistently bring down the outstanding loan amount, as it will directly reduce the principal you owe the bank. Here the only thing you need to take into account is the prepayment fee, which some banks levy if your prepayment exceeds beyond a particular amount.
This could be anywhere between 1 per cent and 3 per cent of your outstanding loan amount. In this case, a handy strategy is to prepay within the limits specified by the bank periodically, which will significantly reduce your outstanding debt and help you close the loan early.
On the other hand, you can still consider prepaying in bulk if you wish to do so, in spite of the prepayment fee if the interest saved is significantly higher.
Here are some reasons that indicate why you should adopt this strategy.
a. Ideally banks offer loan amounts up to a limit of around 50 per cent of your income. This does not mean you should utilise the entire limit available.
Keeping EMI repayments within 30-40 per cent of your budget will help you save nearly 30-50 per cent of your income.
Money management experts recommend that you should try and save up to 60 per cent of your income to help you have enough funds to access, when in need. Though a home is an investment by itself in terms of a fixed asset, you would still need funds that can be liquidated at will, especially if you are a first time home buyer.
The right kind of investments will help you reap rich rewards long term and by saving in spite of EMI repayments will ensure that you start early to save more.
b. A long term loan like a home loan is a debt that is part of your budget every month. If you invest too much into it, there might not be adequate funds to manage a huge list of other expenses that will tend to accumulate with time. For example, you need to make allowances for future expenses like children's education, emergency funds for a job loss or the loss of one income in a situation where two people have taken a joint loan.
c. There might be spikes in interest rates. In such a scenario usually banks will increase the loan tenure in order not to put the borrower in a tight spot by increasing his EMI. In such a scenario if you can manage a slightly higher EMI you can request the bank to adjust the EMI, instead of extending your loan tenure.
d. On the positive side, when your income graph soars with time, as it is bound to under normal circumstances where promotions and job changes take place, you can always choose the prepayment route. It is best not to commit a higher sum that will burn a hole in your pocket, rather it should be the other way around where you can actually control the repayment pattern of your home loan.
e. A home loan may not be the only debt you incur. You might end up taking an education loan for your children or a personal loan for some other purpose. Your debt liability will be taken into account before banks sanction such loans. At such a juncture you will be in a position to leave enough room for one more loan, if need be. This could enable you to invest in a second home also in the long run.
f. Last but not the least, it is very easy to be stressed if some unexpected situation upsets the apple cart. You should have contingency plans in place to avoid your finances toppling like a house of cards leading to undue stress. Your life is something to be enjoyed and cherished, so don't entangle yourself in a web of debt and spoil the fun.
The author is Head of Content & Research at BankBazaar.com
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