Taking a home loan is very common in India as most people avail of this option when they plan to buy a house. Some of them plan to pre-pay their loans to get rid of monthly Equated Monthly Installments (EMIs). The only problem is the pre-payment penalty that you might face while repaying the loan before maturity.
The prepayment penalty is the fee that you need to pay if you plan to repay your loan before maturity. One may think that banks should be happy to be repaid soon but that is not the case. When a bank gives a loan, they earn from the interest that you pay to them while repaying the loan with EMIs. Interest earned is what makes banks lend money to people. If you prepay the loan, the bank loses out on a big amount of money which they expected from you as the interest payment during the tenure of the loan. To make up for that loss, banks have implemented prepayment penalty charges.
Types of prepayment penalty charges
There are two reasons why banks charge you prepayment penalty.
First, if you close the account before maturity by repaying lump sum amount, banks charge pre-payment penalty.
Second, if you transfer your loan to another bank or any lending institute with lower interest rates, the bank will charge you a prepayment penalty.
No more pre-payment penalty on floating rate home loans in India
After several protests against prepayment penalty changes, the National Housing Board has finally barred housing finance companies (HFCs) from charging prepayment penalty on floating rate home loans. However, the Reserve Bank of India said prepayment penalty can be charged on fixed rate home loans, except when the borrower is paying from his own pocket.
What you should do
There are times when prepayment penalty will cost you less than the EMIs itself. In such a situation, it is best to opt for that route. Take expert advice to avoid any calculation mistakes you may make in arriving at a solution.