Repaying or prepaying the loan principal or interest is often considered a sure shot way to reduce the borrower’s financial burden, EMI, and sometimes, the interest rate. However, when you have more than one loan in your portfolio, it may become challenging to choose the best candidate for prepayment.
This article tells you the differences between repaying a home loan and a personal loan, enabling better savings.
Difference Between Home Loan and Personal Loan
A home loan is a cost-effective way to get money when you need funds to construct or purchase a house. Home loan interest rates are often the lowest among loans. In contrast, a personal loan has no restrictions on the end-use. You can spend the fund on anything you like. However, since it is a collateral-free loan, the loan amount is often much lower than a home loan. Moreover, the interest rate is higher than a home loan.
Which Loan Should You Repay First – Home Loan or Personal Loan?
When you avail of a loan, you create a budget for repaying that. Since the home loan amount looks gigantic at first, borrowers often consider repaying the home loan principal first. In contrast, the personal loan amount looks trivial. However, if you analyse correctly, you will discover that a personal loan’s effective interest rate is much higher. Hence, any wise borrower will repay the personal loan principal or interest before repaying a home loan.
Unlike a personal loan, a home loan enables you to claim many tax benefits. You can use the provisions of Section 80C to save up to INR 1.5 lakh every financial year. Similarly, you can use the provisions of Section 24 to save the interest of up to INR 2 lakh every financial year. You can claim these tax benefits for the entire duration of the loan. Repaying home loan EMIs over a more extended period allows you to save tax. In contrast, you cannot claim any tax deduction for repaying a personal loan. Hence, it is prudent to opt for early repayment of a personal loan if you want to save taxes.
A home loan often entitles you to receive various add-on benefits like loan top-up or overdraft facility. You can always enhance the loan limit (provided your credit profile permits so) and withdraw some extra amount. Although such convenience comes at a price, it is often lower than a personal loan. A personal loan seldom offers such value-added benefits to borrowers. Hence, you can hold home loan repayments until the personal loan is repaid, as a home loan may act as a financial cushion during times of need.
Your credit score is a determining factor for calculating the loan interest rate. It takes time to enhance the credit score. As the personal loan tenure is less, regular repayments might not be enough to increase the credit score. Moreover, since a personal loan is unsecured, the impact on your credit score is lower. In contrast, a home loan gives you a longer-term for repayment, and hence, you get better chances to increase the credit score.
There is almost no way to prepay a personal loan without incurring some penalty. Most lenders charge 3-4% of the prepayment amount as the penalty. In contrast, home loans with a floating rate of interest are free from additional charges. Hence, if you want to avoid the prepayment charges, repaying a home loan will be a better decision.
The choice to repay a home loan or personal loan depends on your preference. If you want to reduce the loan cost, get tax and other value-added benefits, repaying a personal loan earlier will be a better decision. However, if the penalty worries you, then you should opt to clear the personal loan earlier. Use a home loan calculator to calculate the savings before repaying either loan.