Indian taxpayers (salaried employees) can choose from the old tax regime and the new tax regime while filing their taxes. Unfortunately, those who choose the new tax regime (which has now become the default tax regime) have to forego several key tax incentives, forcing them to reassess their investment and loan repayment strategies.

For example, under the new tax regime, home loan borrowers cannot claim deductions under Section 80C (up to Rs. 1.5 lakh on principal) and Section 24(b) (up to Rs. 2 lakh on interest for self-occupied property). Thus, it no longer incentivises borrowers to maintain long-term loans. Instead, they can opt to make partial prepayments when they have access to excess funds.

Before you use the income tax calculator for FY 2024-25, let us understand the meaning of home loan prepayment and its benefits if you are choosing the new tax regime.

What is a home loan prepayment?

When you take a home loan, you have the option of repaying a portion of the outstanding principal before the agreed-upon tenure ends. This can either be a:

• Part prepayment, where you make payments in addition to your regular EMIs to reduce the outstanding principal, and thus, the total interest you pay, or

• Full prepayment (also known as foreclosure), where you pay off the entire remaining loan amount, thus closing the loan entirely.

For floating-rate loans, there are no prepayment or foreclosure charges, while fixed-rate loans usually have prepayment or foreclosure fees. Additionally, certain lenders might have a lock-in period during which you cannot make prepayments without incurring extra charges.

For instance, if you apply for a Bajaj Housing Finance home loan at a floating rate, you will have the option of making prepayments without incurring extra charges.

Sections 80C and 24(b): Benefits under the old tax regime

Under the old tax regime, home loan borrowers enjoy several deductions, with the two main deductions falling under sections 80C and 24(b).

• Section 80C: Home loan borrowers can claim deductions of up to Rs. 1.5 lakh on the principal repayment every financial year u/s 80C of the ITA.

• Section 24(b): Under Section 24(b) of the ITA, borrowers can claim additional deductions of up to Rs. 2 lakh on the interest component (for self-occupied property) during the financial year. For a let-out (rented) property, they can claim the entire interest paid as a deduction.

If you have chosen the old tax regime, you must input these figures into the income tax calculator for FY 2024-25 to calculate deductions. That said, you must remember that Section 80C provides deductions of up to Rs. 1.5 lakh per year on different investments, including life insurance premiums, PPF, and tax-saver FDs.

New tax regime: Why prepayment makes sense

It is important to remember that in the initial few years of the loan period, the EMIs you pay are front-loaded. That is, the majority of the EMI amount covers the interest, while only a small portion covers the principal amount. For this reason, making a part-payment, especially in the early years, significantly lowers the interest outgo.

Individuals who choose the new tax regime cannot benefit from deductions under sections 80C and 24(b) (for a self-occupied property). For this reason, it makes sense to close the loan faster. Let us look at an example to understand this better:

Example

Let us assume you have taken a home loan of Rs. 50 lakh, with an interest rate of 8.5% p.a. and a tenure of 20 years. Now, you pay Rs. 43,391 as EMIs every month, while the total interest outgo is Rs. 54,13,879. However, by prepaying Rs. 5 lakh in the third year of the loan, you can reduce the tenure by 3-4 years and, subsequently, save up to Rs. 12 lakh in interest!

Apart from making prepayments, you can also increase your EMIs gradually, which also lets you save a significant portion of the interest while reducing the loan tenure. Taking the above example, here’s how much you can save by increasing your EMIs annually.

Borrowers are also encouraged to use the dual strategy of making prepayments while stepping up EMIs, which ensures maximum savings.

Benefits of prepaying home loans

It is equally important to remember that making prepayments early offers greater savings, as it becomes less effective in the later stages of the loan. Here are some of the key advantages of making prepayments:

• Lowers the total interest: One of the biggest benefits of prepayment is lowering the total interest component, which forms a significant part of your EMIs, especially in the early years. By making lump-sum prepayments, you reduce the outstanding principal, thereby also reducing the total interest you pay on the loan.

• Better allocation of resources: If you clear your loan faster, you can use future funds for other important financial needs. You can use an income tax calculator for FY 2024-25 to understand how much you can save through certain tax-saving instruments.

• Close the loan faster: While opting for a home loan is a long-term commitment, there can be unforeseen circumstances that can disrupt your financial stability. This includes accidents or loss of income. Closing the loan faster through prepayments offers peace of mind.

• Get access to home equity: While real estate is generally considered to be an appreciating asset, it remains locked until you sell the property. However, you can avail of a home equity loan (also called a ‘second mortgage’) by prepaying your home loan and owning the property outright. This lets you borrow urgent funds against your home’s current market value.

Conclusion

For individuals choosing the new tax regime, the inability to take advantage of deductions u/s 80C and 24(b) (for a self-occupied property) makes prepayment an attractive proposition. Furthermore, borrowers must check for hidden charges before prepaying, while ensuring they maintain adequate emergency funds and liquidity before earmarking additional funds for loan repayment.

Running the numbers through an income tax calculator for FY 2024-25 also helps you choose the ideal tax-saving instruments to reduce your income tax liability. Afterwards, you can rely on a Bajaj Housing Finance home loan to finance your home purchase.