Closing Your Home Loan Early? Hidden Costs That Could Hurt Your Savings
Before you decide to prepay your home loan, you need to understand the penalties, lost tax benefits and liquidity concerns.
Paying off a home loan ahead of schedule may seem like a smart financial move, especially if you aim to reduce debt and save on interest payments. However, if you want to maximise your tax benefits, it’s worth reconsidering before closing your home loan. While prepaying a home loan can bring peace of mind, it comes with certain hidden costs that could impact your overall finances.
Tax Benefits On Home Loans
Home loans offer tax benefits under various sections of the Income Tax Act, helping borrowers save on their tax liabilities. Here are the deductions available:
Deduction On Principal Repayment (Section 80C)
Maximum deduction: Rs 1.5 lakh per year
Conditions: To claim tax benefits on home loan principal repayment under Section 80C, the property must not be sold within five years of taking possession. In addition, the deduction includes payments made towards principal repayment, stamp duty and registration fees. However, stamp duty and registration fees can only be claimed in the year they are incurred.
Deduction On Interest Payment (Section 24B)
Maximum deduction: Rs 2 lakh per year
Conditions: A home loan must be taken specifically for the purchase or construction of a house to qualify for tax benefits. The construction of the property must be completed within five years from the end of the financial year in which the loan was sanctioned. Also, any interest paid during the pre-construction period can be claimed in five equal instalments, subject to an overall limit of Rs 2 lakh. But for let-out properties, there is no upper limit on interest deduction, though the total loss under ‘Income from House Property’ is capped at Rs 2 lakh per year.
Additional Deduction For First-Time Home Buyers (Section 80EE)
Maximum deduction: Rs 50,000 per year
Conditions: To qualify for this deduction, the home loan amount must not exceed Rs 35 lakh, and the property's value should be Rs 50 lakh or less. The loan must have been sanctioned between Apr. 1, 2016 and Mar. 31, 2017. This deduction is available over and above the Rs 2 lakh limit under Section 24B, providing additional tax benefits for eligible borrowers.
Additional Deduction For Affordable Housing (Section 80EEA)
Maximum deduction: Rs 1.5 lakh per year
Conditions: To avail of this deduction, the property's stamp duty value must be Rs 45 lakh or less, and the home loan must have been sanctioned between Apr. 1, 2019, and Mar. 31, 2022. Taxpayers cannot claim this benefit if they have already availed of deductions under Section 80EE. This deduction is available in addition to the Rs 2 lakh limit under Section 24B, offering extra tax relief for eligible homebuyers.
Potential Drawbacks Of Closing Your Home Loan Early
Prepayment Charges And Fees
Although Reserve Bank of India (RBI) regulations have eliminated prepayment penalties on floating-rate home loans, fixed-rate loans still attract prepayment charges. This adds to your financial burden.
Liquidity Concerns
Using a large portion of your savings to close a home loan could strain your liquidity. Instead of locking funds into real estate, investing them in diversified assets like mutual funds or fixed deposits could provide better returns while keeping your money accessible for emergencies.
Credit Score Impact
A home loan is a long-term financial commitment that helps build a strong credit history. Regular EMI payments contribute to a healthy credit score, improving your eligibility for future loans. Prepayment closes this credit line, reducing the diversity in your credit profile, which could temporarily impact your credit score.
Opportunity Cost Of Early Repayment
If your home loan interest rate is relatively low, using surplus funds to invest in higher-yielding financial instruments might be a more profitable decision. For instance, equities or high-return debt instruments can potentially offer better growth than the savings from loan prepayment.
Overall, closing a home loan early has its advantages, but you need to consider the hidden costs and lost benefits before making a decision. A balanced approach — such as partial prepayments while continuing to enjoy tax benefits — could offer the best of both worlds. Before making a move, consult a financial expert to assess your situation and ensure your decision aligns with your long-term financial goals.
