BackIs prepaying your home loan the best choice? Here's how to decide
Home loan prepayment is a crucial decision for many. Making prepayments at different times can have a significant impact on reducing total interest and loan tenure. The earlier the prepayment is made, the greater the savings.
PremiumHome loan prepayment is a sensitive topic. Most people would love to be loan-free soon. And hence, they often resort to prepaying. But there are also others who believe that given the tax benefits on offer (under the old tax regime), there is a case to not prepay home loans.
If you belong to the latter, then this article will not resonate with you. But if you too have a big home loan and you feel burdened with it, then the idea of prepaying your loan would have already crossed your mind.
Also Read: Top 5 banks offering low interest rates on home loans; check full list
Making prepayments at different times has a different impact on your home loan journey. And the best way to understand how, is to illustrate with an example.
Suppose you take a ₹50 lakh home loan for 25 years at an 8.5% rate of interest. Your monthly EMIs will be ₹40,261 and during the course of 25 years (assuming regular EMIs but no prepayments), you will not only repay the original ₹50 lakh principal, but also an interest of ₹70-71 lakh.
Monthly EMIs are structured in a manner that it has two parts – principal and interest. And the ratio of the two changes throughout the loan tenure. And home loans are front-loaded when it comes to interest servicing.
Also Read: Want to take a home loan overdraft facility? Here are its pros and cons
What this means is that during the initial years, a major part of the monthly EMI goes towards interest servicing and a very small part goes towards principal repayment. But with each passing year (or even month), the share of principal in the EMI keeps ticking up and that of the interest component keeps ticking down. And it is this front-loaded structure of interest that the earlier you make a prepayment in the tenure, the better it is.
So, say on a ₹50 lakh home loan, if you decide to make a single, one-time prepayment of ₹5 lakh, then how it impacts the total interest burden and the loan tenure varies with the time of prepayment.
Let me show this by extending our example:
No Prepayment: If you don’t make any prepayment, then the total interest paid will be ₹70-71 lakh. Loan Tenure will remain the same as the original 25 years.
Prepayment of ₹5 lakh at the start of 2nd year: If you make a one-time ₹5 lakh prepayment at the start of 2nd year, then the total interest paid reduces to ₹46-47 lakh. That’s a massive saving of ₹24-25 lakh and the loan tenure also reduces by 6 years.
Also Read: Tax efficiency 101: How to maximise income tax benefits on home loans
Prepayment of ₹5 lakh at the start of 5th year: If you make a one-time ₹5 lakh prepayment at the start of the 5th year, then the total interest paid reduces to ₹52-53 lakh. That’s a saving of ₹18-19 lakh and the loan tenure also reduces by about 4 years.
Prepayment of ₹5 lakh at the start of 10th year: If you make a one-time ₹5 lakh prepayment at the start of the 10th year, then the total interest paid reduces to ₹59-60 lakh. That’s a saving of ₹11-12 lakh and the loan tenure also reduces by about 3 years.
Prepayment of ₹5 lakh at the start of 20th year: If you make a very late one-time ₹5 lakh prepayment at the start of the 20th year, then the total interest paid reduces to ₹68 lakh. That’s a saving of just ₹3 lakh and there isn’t much of an impact on loan tenure reduction.
Note – We have kept the home loan rate constant at 8.5% for simplicity, though the rates will fluctuate given the floating-rate nature of most home loans.
Also Read: Top-up home loans: Tenure, interest rate, and other things to keep in mind when applying
In each of the above cases, we made a payment of the same ₹5 lakh as prepayment. But as is clear from each of the examples, the earlier the prepayment is made, the bigger its impact on saving interest and tenure reduction.
This was about making a one-time large prepayment. This is feasible for those who get large bonuses/incentives once a year.
But what about those, who for some reason, are never able to access large surpluses? What can they do?
For them, making periodic smaller prepayments is the way to go. And there too, the earlier they can start those prepayments, the better it is. Suppose in the above example, the borrower decides to make ₹5000 monthly prepayment from the first EMI itself.
In this case, the total interest reduces to ₹47-48 lakh (from the original no-prepayment scenario of ₹71-72 lakh). And the tenure also comes down to 19 years. Not bad for just a small additional monthly prepayment of a few thousand that you can manage.
So as would have been abundantly clear by now, the earlier you prepay your home loan, the bigger its impact.
Dev Ashish is a Sebi-registered investment adviser and the founder of Stable Investor.
3.6 Crore Indians visited in a single day choosing us as India's undisputed platform for General Election Results. Explore the latest updates here!
