Saturday, 19 February 2011

Pay back your housing loan early instead of investing in Tax saving Schemes.

You may be aware that the interest and Principal amount repayment of housing loan allow you to get tax exemption. You will get tax exemption for the principal amount repayment of housing loan up to Rs. 100000 in a year together with other tax saving investments under section 80C. And also can avail Tax exemption for the interest payment for housing loan up to Rs. 150000 in a year under section 24(b).

You may do some tax saving every year in Life insurance, NSC, PPF and other tax saving instruments. All these schemes allow you to get tax exemption under section 80C, subjected to the total of Rs. 100000. Most of these schemes allow an interest around 8% and most of these interests are taxable. But the interest of your housing loan may be more than 8%. Then why don’t you pay back your housing loan instead of saving in Tax saving investments.

Normally you pay back housing loan in EMIs (Equated Monthly Installments) and the housing loan providers charge interest for the remaining balance every month (on daily basis or as per their terms). Most of the Financial Institutions now allow one lump sum repayment in a year without penal interest, if the payment is from own source of income. If you pay back an additional payment in lump sum, it can be treated as principal amount, because the interest is already charged from your EMI. In such a way you can close your housing loan early than you agree with the loan provider, when you take the loan.

Some investment experts may say that this is not a wise decision, so that the housing loan gives you subsidized interest and you cannot get such a low interest loan from anywhere else. But our opinion is that it is better to repay the housing loan than invest in other tax savings investments which gives you only around 8% interest. If you don’t have any other emergencies, you can redirect the money which you wish to use for tax saving investments, for repaying your housing loan and can get the same tax exemption and an early release from the long term liability of housing loan.

The  Table below Narrates the Gain in interest when you make a yearly pre payment option of Rs. 20000, 30000, 40000 and 50000 each and within the number of months you can finish your loans, total amount of prepayment in each prepayment options and the last column show the amount of gain in interest for each option.

You may have other commitments such as LIC, School Fee and the minimum amount to be invested in PPF etc. and the remaining amount you can repay in housing loan and get the full benefit of section 80C for the repayment of housing loan and reduce your number of installments of EMI. The table shows that if you could pay Rs. 20000 as pre payment every year you can pay off your 20 year loan in 13 years and 6 months with a gain of Rs. 459602 (in interest) in addition to your tax gain. The table is prepared for a housing loan of Rs. 1000000 with 9.5% interest for 20 years and the prepayment is done in the first 6 months and thereafter every 12th month. The figures may be slightly changed with rounding off.

The above mentioned plan is profitable only if you do not require other high interest loan in near future. If you have any other loan with high interest, pay off that loan first instead of paying off the low interest housing loan.

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Yearly  PrePayableprincipalPrincipalTotalTotalGain  in
EMIPaymentMonthsThru EMIprepaidinterestAmt PaidInterest
9322024010000000123711622371160
9322200001627355392644617775141777514459602
9322300001406400003600006584511658451578665
9322400001266000004000005744591574459662657
9322500001145500004500005101121510112727004

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