Interest rates have once again started rising. The Reserve Bank of India has increased the repo rate by 25 basis points to 6.5 per cent for the second time in two months. Banks, accordingly, have started increasing their Marginal Cost of Lending Rate (MCLR) signalling a rise in home loan rates. For example, Kotak Bank, Union Bank, and Karnataka Bank have already hiked their MCLR by 5-10 bps, which will increase their home loan rates. One basis point is one-hundredth of a percentage.

In such a scenario, should you transfer or prepay the home loan?

Transfer Your Home Loan

You can consider transferring your home loan to another bank if you are paying a high-interest rate. But while transferring, do remember that there should be at least 50 basis points difference between an old and new rate, otherwise it won’t be worth taking so much trouble.

There are other costs also such as processing fees that need to be taken into account while transferring your loan amount. You should also ensure that your property documents are transferred to the new bank as many times they get lost in the process of transit.

Prepay Your Home Loan

If you don’t have any liquidity issues, then you can consider prepaying your loan amount. But again before prepaying the loan amount you need to consider few things. First, it is always good to prepay loan amount in the first five years of the loan term as it is the period during which interest payout is maximum. By pre-paying principal amount at the early stage, you can bring down the interest amount substantially.

Second, you also need to consider tax benefits, as there is a tax deduction of Rs 2 lakh that you get on interest payment under section 24(b) of the Income Tax Act, 1961. By availing the tax break on your home loan interest, the effective cost of the loan goes down.

You can, therefore, prepay the home loan amount but at the same time can keep it at the level so that you can avail interest deduction of Rs 2 lakh. For example: at the rate of 9 per cent to avail the interest deduction of Rs 2 lakh, the loan amount should be Rs 23 lakh for the tenure of 10 years.

By availing tax benefit, your effective interest rate on the home loan can come down substantially.

Having said that, if you are already earning double-digit interest on your investments, then do compare benefits that you will give up by prepaying your home loan amount.