Question
I took a floating rate home loan in 2002 when the interest rate was 7.25%. The rate has now risen to 12.5%. Should I withdraw from my PPF account, which gives me 8%, to repay a part of the loan? I also get tax benefits on the home loan.
—Birender Rawat, Secunderabad
Answer
The rise in interest rates on home loans has upset the calculations and repayment schedules of many home buyers, especially those who had opted for floating-rate loans. In some cases, loan terms have stretched to 25-30 years, even though the borrower has paid EMIs for three or four years. If the loan tenure extends beyond retirement age, banks also raise the EMI. This is a double whammy for the borrower, who ends up paying more and for a longer time.
In the present situation, it is a good idea to liquidate your PPF account, which gives you 8% interest, to repay a 12.5% home loan. Although interest rates appear to have peaked, experts believe it will be some months before they start falling. You stand to gain by liquidating a low-yield investment to repay a high-cost loan:
Interest rate on home loan: 12.5%
PPF interest rate: 8%
You save: 4.5%
When it comes to the tax benefits you get on a home loan, remember that these benefits are available only on the interest you pay on the loan. The tax saved is far lower than the interest you pay.
That’s why it makes sense to opt for the shortest possible repayment tenure. This reduces the total interest outgo on your borrowing. The following table shows how a small increase in EMI can make a difference in the total outgo.
Assume you took a 25-year loan of Rs 10 lakh at a rate of 12%. Your interest cost is almost Rs 22 lakh. Reduce the term to 10 years, and the interest cost is only Rs 7.22 lakh. Here, it makes sense to prepay your loan; consider these options.
Outstanding loan: Rs 5.6 lakh
Current EMI: Rs 11,740
Tenure remaining: 66 months
EMI raised to: Rs 14,900
Loan ends in: 48 months
Prepay (from PPF): Rs 1.5 lakh
EMI raised to: Rs 13,800
Loan ends in: 36 months
Of course, both these options assume that the interest rate will remain at 12.5%. If, however, rates fall, you can repay your loan even earlier and save more.
