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Home loans? Should you repay or not?

The idea of being debt-free especially on your housing loan is very attractive. But if you are young and planning to shift into a bigger home or buying a second home, you may be better off not repaying that home loan.

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The idea of being debt-free especially on your housing loan is very attractive. But if you are young and planning to shift into a bigger home or buying a second home, you may be better off not repaying that home loan.
This is because, while repayment helps you save on interest charges, payable to the bank for use of their funds, but it could lead to opportunity loss. Take the case of Ajinkya Shetty*.

In 2001, Shetty bought his first flat with a princely loan of Rs 8 lakh. Within the next five or six years he had repaid the entire loan. Around the same time, he had a child and wanted to buy another house in a better locality. He was hoping to sell his existing flat to fund the new house. Unfortunately, he discovered that even if he came across good deals, he was unable to close the deal as he did not have the funds for the down payment. And he could not sell his existing house till he had finalised a new house.

This was the period that real estate prices in Mumbai were on the rise. By the time, Shetty bought the new house, he ended up paying a much higher price. ``The house which was costing around Rs 35 lakh in 2006 was now selling for Rs 1.2 crore in 2011,'' says Shetty.

Of course, real estate prices have stabilised since then. But the point is that plan your financial needs before you decide to be totally debt-free. ``After all, you don't want to have zero funds in your bank,'' says Shetty.

That said, the fact is there are benefits of repaying a housing loan. For one, your credit score improves. ``In case one pays back a home loan or any other loan, the fixed obligation of the customer drops and therefore the debt burden ratio also drops. This may potentially impact one's credit score positively, all else remaining equal prior to and post prepayment. The prepayment of unsecured loans are expected to have higher positive impact on credit score vs prepayment on secured loans,'' says Nimilita Chatterjee, senior VP – products, analytics and data operations at Equifax.

Secondly, you end up saving money that you would have paid the bank towards interest charges. ``The amount of savings will depend upon the amount that is prepaid and at what time the pre-payment is made. The earlier the payment, the higher the savings because interest will be calculated on a lower figure provided the loan is on a reducing balance calculation method,'' says Arnav Pandya, Certified Financial Planner (CFP).

At times, repayment of the home loan is recommended. For instance, if you are an actor or a professional with an irregular income, your bank balance could see sometimes famine, sometimes feast kind of situation. In such cases, it does make sense to pay off the home loan or other loans as soon as possible, so that there is no pressure of paying the equated monthly instalments (EMIs) during the lean periods.

But for those of you, who have a regular job and are assured of a fixed income (barring unforeseen circumstances), you could continue with the bank loan, even if you are not planning to move into a bigger home. ``It is not a bad idea to continue with a housing loan as a housing loan helps in building an asset,'' agrees Pandya.

Besides, of all the different types of loans, ``the interest rate for housing loans is comparatively lower and there are tax benefits too,'' points out Pandya.

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