Making payments on your home loan isn’t an easy-breezy deal. There are times that your salary is not enough to fulfill a loan payment. However, if you’re lucky to have extra money at your disposal, chances are you might be thinking of paying your home loan ahead of your team.
This article provided by Clopton Capital will help you think through the conditions and possible setbacks when doing prepayments on your home loan. After this, you will gain more understanding of how home loan prepayment works and will make you decide whether you’ll fulfill the loan term in advance or not.
What happens when you prepay a Home Loan?
Making a prepayment is not just all about meeting a payment term in advance. It is more than paying two or three payment terms in advance. Let us remember that a home loan consists of the amount of money borrowed to pay the entire house value from the moment it was sold to you plus interest rates the bank has set for the loan. Some financial companies, like banks and lending agencies, add specific fees on top of your loaned amount.
When you prepay a loan, you are making an advance payment on your principal loan amount, which excludes other fees and interests. Thus, prepayment of a home loan has an impact on your mortgage in terms of its equated monthly installment (EMI) or the number of years you need to pay, which is called the loan tenure.
However, the prepayment does not cover the loan interest, which is incremented as the loan tenure gets older. There are serious issues surrounding prepayments of home loans that need a serious thought about it. If you consider making a prepayment on your home loan or someone encourages you to do so, you may want to think it over first. Read this article, or call your financial advisor to ask advice regarding prepaying your home loan.
Advantages of Home Loan Prepayment
As any prepayment of loans, doing the same with your home loan has its advantages. While the most obvious benefit is reducing your principal quickly, there are other advantages you can get while making advance payments on your home loan. Here are some of them.
- Prepayments reduce the interest you pay every term. The extra amount you add to your monthly payments when covered on the principal amount will affect the interest rate of the future payment term. This means that the interest rate will be cut down a bit. This will work to your advantage as you get to save a bit more.
- It would also save you more money and will outweigh the amount you have collected from taxes. As aforementioned, your prepayment on your principal reduces the interest rate per month if you pay in advance. Thus, you will get savings that are much higher than the homeowner tax incentive.
- It can help you build your house equity. However, the best prepayment technique to build equity is to add an extra amount on top of your EMI. It reduces the loan term, interest rate, and combines more savings from your loan, which can be used to pay your mortgage fees.
Disadvantages of Home Loan Prepayment
While success stories on loan prepayment are circulating online plus your family and friends vouching on the benefits of making loan pre-payments, it is also good to look at the caveats in making loan pre-payments. Being aware of the possible setbacks will help you manage your loan payments, avoid penalties, and incur fees that weren’t supposed to be there if not for the extra payments made.
- It gives you less liquidity. There is so much you can do with the extra cash than use it to settle your home loans in advance. If you put all that additional amount in a single liability, chances are you wouldn’t have prepared yourself for emergencies that can be saved by that extra amount you’ve just prepaid to your loan.
- Borrowing costs are much higher for making loans against your already-paid home. If you intend to borrow some extra cash from a lending agency and putting your home as collateral, say for an additional mortgage, you will find yourself paying more than what you should have. House values have collapsed since 2006, and a lot of financial regulations on mortgaging and credit standards have tighter regulations now than they were five to ten years ago.
- There is a lesser opportunity for investment returns for real estate versus other traditional portfolio investments. You would find it more profitable to invest your extra money on the stock exchange than to your own home. On a worldwide average, only a 6-8% increase in revenue can be obtained from your house value, if paid five years ago and sold today, versus the 15-20% revenue from stocks that you can get for less than five years. Real estate is not a highly-proliferating investment.
- The inflation hedge keeps your loans paid in future valuation. You are paying your equity at a future price. Your current mortgage, set in future values of currency (e.g., dollars, pounds, etc.), will have lesser value when liquified today. Making a prepayment is not good when prices are set in the future.
It is best to talk to a financial advisor about home loan prepayments before doing it. You can consult your bank or lending institution about advanced loan payments, so you will know the process, the fees, and the incentives or penalties attached to it. To know and understand better, the loan terms will help you gain more from your monthly payments, help you get your house fully paid, and increase your credit score altogether. This way, you would be able to balance your sheets, manage expenses, and even use the extra cash for other profitable activities or as an emergency fund. There is nothing wrong with making advance payments for your home loan, but it is not practical to do it with ignorance on the terms, the side straps, and the catches in doing so. Having a solid understanding of home loan terms will help you get your loan done without any future problems and have your mortgages done before you retire from work soon.