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What is the Prepayment Penalty on a Home Loan and How Can It Be Avoided?

What-is-Prepayment-Penalty-on-a-Home-Loan-and-how-it-can-be-avoided

In a home loan, the interest cost forms the major part of total repayments. Therefore, to reduce the impact of interest cost on the home loan, many borrowers opt for prepayment.

Prepayment is a mechanism to repay the principal part of the home loan earlier than the home loan repayment schedule. It is a very common strategy used by borrowers to lower the overall homeownership cost when buying a home using a home loan.

However, the lender sometimes charges the borrower some amount as a penalty for making prepayments, also known as a prepayment penalty.

In this blog, we will understand what a home loan prepayment penalty is and ways to avoid it.

The details of the statement include:

What is a Home Loan Prepayment Penalty?

A home loan prepayment penalty is a fee charged by the lender when you make part or full prepayment of your home loan before the due date. The prepayment charges* depend on the time left for the home loan tenure and as per the terms agreed while availing of the home loan.

As per the guidelines issued by National Housing Board in 2011, a lender cannot charge a prepayment penalty on a home loan under the following circumstances:

  • When the home loan is issued on a floating interest rate basis, irrespective of the income source of the prepayment amount.
  • When the home loan is issued on the fixed interest rate and prepayments have been made through own sources.

Own sources imply payments made from any sources other than refinancing of loans through banks, NBFCs, and financial institutions. Please note that prepayment or part-payment terms and conditions vary among lenders, and it would be a good idea to have a discussion with your lender and read the terms and conditions on the loan agreement so that you can make an informed decision.

Things to Do Before Making a Prepaying Home Loan?

If prepayment charges are applicable to you before making early repayment of a home loan, you should consider the following things:

  • Calculate the net savings in interest cost when you make early repayment of a home loan. Make sure prepayment of a home loan doesn’t impact your other financial obligations.
  • Evaluate all the tax benefits that you may lose when you prepay the loan. If the total tax benefits are more than the savings of interest cost from early repayment, don’t consider making a prepayment.
  • Do not opt for a higher EMI amount to shorten the loan tenure in haste. You must always consider your overall budget, and any future expenses such as children’s school fees, emergency savings, and so on before making a decision.
  • If you are choosing to prepay the loan earlier, choose to do it at the beginning of the loan tenure rather than doing it at the far end of the loan tenure. It will help you in greater savings of interest cost.

How to Avoid Prepayment Penalty?

It’s very common for borrowers to make prepayments and close the home loan account early. Therefore, to avoid an early payment penalty, you should keep room for prepayments when you are planning to take a home loan and calculate the EMI. It will help you to choose the loan type accordingly. For example, by going for a floating interest rate, you can avoid a penalty for paying off mortgage early.

Similarly, you should consider negotiating with the lender to increase the home loan EMI for the remaining tenure, which will provide you similar benefits to making unscheduled prepayments.

Must Read : What is Home loan Prepayment?

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