Pay Attention To These 7 Things About Your Home Loan And Be Debt-Free Faster
If your objective is to be debt-free fast, you should adopt a proactive approach to managing your loan
The debt-free life is very attractive to homeowners. Your typical home loan can last for 15-20 years long, sometimes longer. But you don’t need to be in debt that long. In fact, if your objective is to be debt-free fast, you should adopt a proactive approach to managing your loan. Here are 7 things you can do today in 2024 to ensure you're optimising your loan payments for becoming debt-free faster.
1: Check Your Benchmark
Check your loan for its benchmark. Every home loan has a benchmark rate. Some examples are Base Rate, Prime Lending Rate, MCLR, or Repo-Linked Lending Rate.
Today, the most prevalent benchmark for home loans is the repo rate. This is the rate at which the RBI lends to banks. The repo rate is 6.50% today. All bank home loans issued since October 2019 are linked to the repo.
Consumers prefer the repo rate for two main reasons. It’s transparent. Since it’s set by the RBI, there can be no doubt as to what your benchmark rate is at any point. Secondly, when the RBI resets the repo rate, your home loan rate will reset by an equal margin within three months.
These two reasons take away all uncertainty about how much your floating rate could change and when. In the older benchmarks, MCLR addressed the “when” but not the “how much”. This was a constant problem and made loans costlier than the RBI wanted it. As a result, the RBI mandated banks to shift away from MCLR towards repo. If your loan was taken before October 2019, there’s a huge chance it’s costlier than fresh loans. So take control.
2: Check Your Spread
Next, the spread. The spread today is the part of your home loan rate over and above the repo rate. So if your rate is 8.75% with the repo at 6.5%, your spread is 2.25%. The spread, thanks to the RBI, needs to be fixed for the length of your loan. This takes away all uncertainty about rate changes. Today, the lowest home loan spreads are between 1.70-2.00%. If you’re on a spread more than 50 basis points higher than what you’re eligible for today, you should probably consider refinance.
3: Refinance
The interest rates on older loans are almost always higher than the rates being offered on new loans today. This is a good reason to keep a watch on market rates and switch when the need arises. If you have more than half the loan and/or half the tenor unpaid, consider a refinance.
Today, the lowest rates in the market are 8.20 to 8.50 for eligible borrowers. Eligibility is based on your credit score, income source, and the loan size. If your score is more than 800, you have demonstrably stable income, and your loan is under ₹50 lakh, most lenders can offer you their lowest rate.
Refinance cases also get additional rate discounts. You can refinance in two ways. Ask your own bank for a cheaper repo-linked loan. The paperwork and processing fee should be minimal. If your own lender hasn’t got a good offer for you, transfer the loan to another lender. This involves more paperwork and higher costs – around 1-2% of the loan, all combined. With a sizeable rate difference of 50 basis points or more, you’ll easily recover this cost within a few quarters.
4: Break-Even Your EMI
Your EMI consists of interest and principal payments. In the initial years, you pay more towards interest and less towards the loan. If you take a loan of 8.50% for 10 years, then it takes two years for the loan and interest payments to become equal i.e. break-even. It’s seven years for a 15 year loan, 12 years for a 20 year loan, and 24 years for a 30 year loan. Make this journey to break-even faster. Start pre-paying when you can so that your breakeven is achieved faster. The faster you get to breakeven, the more you can save on interest.
5: Get To Halfway Fast
Suppose your loan rate is 8.50%. If the loan was taken for 10 years, it takes 73 months to repay just half of it. For a 15 year loan, it takes 117 months. For a 20 year loan, it’s 166 months. For a 30 year loan, it’s 273 months. About 70% of the time is spent repaying the first half of the loan, after which you rapidly move towards loan closure. Till you reach the halfway mark, your interest burden remains heavy. Ask the bank to email you your loan amortization table. Read it to find the halfway mark month. Make the journey to halfway quicker and pre-pay aggressively till you get there.
6: Use The 5% Method
This is my favourite method because it helps you glide out of debt while also leaving money in your hand to invest, spend, and enjoy life. The method is simple. At the start of every loan year, pre-pay 5% of the loan balance. This will help pay down a 20-year loan in just 12 years.
Each year, as the loan balance gets smaller, your pre-payment will also get smaller. This will leave you more savings to invest or spend. At the same time, your EMIs will become more effective each year and will help pay back 66% of the loan, while the rest will come from pre-payment. You could always go faster or slower than 5% basis your financial goals or situation.
7: Voluntarily Hike Your EMI
Pre-payments need to be multiples of your EMIs. Many banks are fine with 1xEMI. Some insist on 2x or 3x. This is often hard to achieve. Which is why voluntary EMI hikes are a smart way to bypass this system and pre-pay much smaller amounts. If you have a 20-year loan at 8.50%, increasing your EMI by just 10% at the start of each loan year will help you pay the loan in full in about 7 years. Go higher or lower than 10% basis your income.
These are some simple, smart, effective ways to get out of debt fast. A proactive approach will help you save lakhs of rupees on your home loan and enjoy peace of mind.
The author is the head of communications at Bankbazaar.com. This article has been published as part of a special arrangement with BankBazaar.
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