Is there a charge on prepayment of home loan?

Have some extra cash and want to close the home loan? Well, it’s a good idea, as you will be free from the interest burden, which is usually several times of the principal amount. But prepayment of loan comes with some charges.

 

Why do lenders charge prepayment fees?

 

Lenders impose prepayment charges primarily to protect their financial interests. When a borrower repays a loan early, especially during the initial years, lenders lose out on expected interest income. This is particularly significant for fixed-rate loans, where the lender has calculated future earnings based on the original loan term. So, lenders demand prepayment charges to close the loan.

 

Prepayment charges

 

“Currently, for floating-rate home loans, borrowers don’t have to worry about extra charges when they make part or full prepayments —no penalties apply to these types of loans. However, with fixed-rate home loans, there’s a different rule. Here, borrowers may face foreclosure charges (may vary from one bank to another) if they choose to pay off the loan early. Since the interest rate in a fixed-rate loan remains constant throughout the loan term, both banks and housing finance companies (HFCs) are allowed to charge a prepayment penalty on early repayment,” Adhil Shetty, CEO of Bankbazaar.com.

  Is there any exception

 

“HFCs can’t charge a penalty if you’re prepaying with your own funds. They only levy this charge if you’re refinancing the loan with funds from another bank or HFC. When you plan for prepaying your home loan, always consider any potential prepayment fees in your decision-making,” Adhil said.

  Types of prepayment charges

  Prepayment fees can be structured in various ways:

 

Percentage of outstanding principal: Most lenders charge a percentage (typically between 1 per cent and 3 per cent) of the outstanding principal when a borrower opts for early repayment.

  Fixed fees: Some lenders may specify a fixed fee for prepayment during certain periods (e.g., Rs 50,000 in the first year, decreasing in subsequent years).

  Months’ interest: In some cases, lenders might require payment equivalent to several months’ interest as a penalty for prepaying the loan.

 

Evaluating the decision to prepay  Before deciding to prepay a home loan, borrowers should consider several factors:

 

Financial goals: Ensure that prepaying does not compromise funds needed for other financial goals or emergencies.

 

Investment opportunities: Compare potential returns from investments against savings from reduced interest payments by prepaying the loan.

 

Stage of loan tenure: The benefits of prepayment are more pronounced in the early stages of a loan when interest payments dominate EMIs. As the loan matures, less interest is paid, making prepayment less beneficial.