Bank FD or Pre-payment of home loan

POSTED BY Ravi ON February 9, 2012 12:21 am COMMENTS (6)

Hi,
Last year in February, I earned 5 lacs. To use this money in hour of need, I deposited in a bank FD of 19 months @9.25%. I also have a home loan running and current outstanding principal is around 8 lacs with ROI 10.5%.
Now I came to know that the interest on Bank FDs is taxable. Now I feel sorry that I should have made a pre-payment of the home loan. That way the money would have been put to best use.
As of today, there are 7 months remanining for the FD to mature.
So, at this moment,
1. Should I break the FD and make a pre-payment of the home loan or should I wait for the FD to mature?
2. How much tax will I have to pay on maturity?
Pls advise.
Thanks in advance.
Regards

6 replies on this article “Bank FD or Pre-payment of home loan”

  1. Ravi says:

    Thanks BFA for your detailed response and I apologise for not responding sooner as I was travelling.

    Your calculations will really help to take an informed decision.

    My loan agreement doesn’t have a prepayment penalty clause except in case the whole of remaining principal is financed by another bank/financial institution.

    Thanks,
    Ravi

  2. BanyanFA says:

    Hi Ravi,

    The details provided by you changes the picture slightly.

    Sorry about throwing a lot of numbers but the situation would look like this :

    A> If you get Rs. 536,000 and you prepay your Housing Loan (assuming no prepayment penalties) – you would save Rs. 32,048 Interest by end of 7 months. If you take away the tax advantage (30% in your case), then you would have a net interest saving of Rs. 22,433 (32048-30% tax advantage which you have to forgo as you didn’t pay interest on Home Loan).

    B – If you decide to continue with FD, you would get Rs. 577,000, an extra Rs. 41,000 interest. After Tax, this extra amount shall be Rs. 28,700 (less 30%).

    If you compare both situations, I think you may still benefit to continue with your FD till maturity. You will earn an extra Rs. 28,700 (after tax) from your FD, while you would have paid net Rs. 22,433 (after tax adjustment). I haven’t even considered the prepayment penalty which the banks generally charge if you don’t prepay the entire Housing loans in one go or prepay more than 25% of the outstanding balance in one year.

    Other people on this discussion, please correct me if my calculations are screwed up.

    Regards
    BFA

  3. Dear ravi, what’s your current yly income & please confirm from the bank, the effective amount you ‘ll get if you opt to break it now.

    Please post the details.

    thanks

    Ashal

    1. Ravi says:

      Thanks BanyanFA and Ashal for your responses.

      My annual income before any deduction is around 12 lacs. That means I am in the 30% bracket.

      I enquired from bank and found that if I break the FD now I will get approx. 5,36,000 but the maturity amount is 5,77,000.

      Here are the points coming in mind:

      1. If I break the FD, I may lose some interest amount but will save some on tax.
      2. If I make pre-payment I will save some interest to be paid to the bank but on the other hand I will lose some deduction advantage.

      Not sure which is the best way forward.

      Pls advise.

      Regards,
      Ravi

      1. Dear Ravi, Please confirm that the 36K interest you are getting from preclosure of your FD is after deducting Tax or pre tax?

        Thanks

        Ashal

  4. BanyanFA says:

    Hi Ravi,
    I understand your financial Dilemma. To help you take an informed decision, let me help you with the following facts :
    1. If you would go ahead to break your FD as of now, you would have been into the FD for around 12 months. For premature payment of your FD, the bank shall deduct a penal rate of interest. In order to calculate this rate, the bank shall find out what is the current rate for 12 month FD and deduct 1% from it. It is approximately 8%-1% = 7% interest rate which shall be provided on your FD, despite of the fact that you would have initially booked your FD for 9.25%. Hence you would notice that you would tend to loose 2.25% or 24% of your Income on Premature withdrawal.

    2. For your home loan, though you pay 10.25% interest, you can claim upto Rs. 1.5 lacs interest paid on your homeloan as a deduction towards your taxable income. Considering you are earning 5lacs, you would be in 10% tax slab. As per this, your actual interest burden would not be 10.25%, but 10% lesser. If you are earning more than 5 lacs, your interest burden on home loan would be 20% lesser.

    3. On maturity, you would have to add interest on your FD to your ‘Income From Other Sources’ in your tax return. This would mean that you would have to pay approx 10% tax on your Interest Income (if you are earning approx 5lac). If your earning is more than 5 lacs, then your tax burden on FD would be 20%.

    It all depends upon the penal interest rates charged by the bank as of now. However, my initial rough calculation suggests that owing to you already completing 12 months of your FD, the next effect should not be much and hence instead of taking the pain, you may want to let the remaining 7 months expire and get the FD funds into your bank account which you can then use to invest gainfully or repay your Home Loan.

    Regards
    BFA

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