The Power of Prepayment
Home loans are typically the longest debt anyone carries, spanning 20 to 30 years. Over such a long period, you often end up paying the bank more in interest than the original loan amount! However, small extra payments can drastically reduce this burden.
How It Works
In the early years of a loan, a huge chunk of your EMI goes towards interest, and very little reduces the principal. By making an Extra Payment, the entire amount goes directly towards reducing the Principal. This has a ripple effect: a lower principal generates less interest next month, leaving more room for principal repayment. This effect compounds over years.
One EMI Per Year Strategy
A popular strategy is to pay just one extra EMI per year. For a 20-year loan, this simple habit can shave off nearly 3 to 4 years from your tenure and save you lakhs in interest. You don't need a bonus; just saving a little monthly (as calculated above) achieves the same result.
Prepayment Charges
Under RBI guidelines regarding floating rate loans:
- Individual Borrowers: Banks CANNOT charge any foreclosure or prepayment penalty. It is free.
- Fixed Rate Loans: Penalties (0.5% - 2%) may still apply. Always check your loan agreement.
When NOT to Prepay?
Mathematically, you should not prepay if your investment returns are higher than your loan interest rate (adjusted for tax). If your Homa Loan is at 8.5% (effective 6% after tax benefit), but you can earn 12% in Mutual Funds, it is better to invest the surplus rather than pay off the cheap debt.
Prepayment vs Investment
Let's say you have ₹1 Lakh surplus.
- Option A (Prepay): You save ₹1 Lakh x 8.5% = ₹8,500 interest annually (Guaranteed).
- Option B (Invest): You invest in Nifty 50 Index Fund. Historical return ~12%. You earn ₹12,000.
However, prepayment offers "Peace of Mind", which has no price tag. Being debt-free is a psychological win.
FAQs
- Does prepayment reduce EMI or Tenure?
- By default, banks reduce the Tenure (keep EMI same). This saves the most interest. If you want to reduce the EMI (monthly burden), you must explicitly request it.
- Is there a limit on prepayment?
- Usually, no. You can prepay as little as one EMI amount or as much as the full outstanding balance. Some banks may have a minimum threshold (e.g., 2 EMIs).