Almost everyone wants to close their home loan soon. A home loan is a big liability and getting this burden off the head is important for most households. Of course, there is only one way to close the home loan soon: Pay more than the EMI. There is no other way. Yes, a reduction in loan interest rate (and keeping EMI constant) will also reduce loan tenure, but the impact won’t be huge. Moreover, this is beyond your control and interest rate upcycles will mostly negate the impact of the interest rate downcycles.
If you have been following the economy and markets news, you must be reading that interest rates may go down soon. There is no certainty, but if this were to happen, it would be a favorable development for the home loan borrowers. Lower interest rates mean lower EMIs or reduced loan tenure.
If you have been thinking about home loan prepayment, would the tailwind of lower interest rates help you? Yes, it would. Let’s see how.
Lower Interest Rates: Accelerate Home Loan Closure with Prepayments
Usually, we read about loan prepayments when the interest rates are rising. And that makes sense too. Everything else being the same, an increase in interest rate will increase either the EMI or the loan tenure. Neither is a preferred outcome. Prepayments during such times can keep both EMI and loan tenure under check.
However, when the interest rates are moving down, you can get the tailwind of lower rates behind you, and you may be able to close the home loan even sooner. Nothing new here. That’s just how loan mathematics works. Let’s understand with the help of an illustration.
- O/S Home Loan: Rs 75 lacs
- Loan Interest Rate: 9% p.a.
- Remaining Loan tenure: 20 years
- EMI: Rs. 67,479
| Interest Rate Change | Revised Interest Rate | Revised Loan Tenure (Years) (without changing EMI) | % Change in Tenure | Revised EMI (Without changing tenure) | % Change in EMI |
| 2% | 11.00% | Not possible without increasing EMI or making part prepayment | NA | 77,414 | 14.7% |
| 1.50% | 10.50% | 34.4 | 72% | 74,878 | 11.0% |
| 1% | 10.00% | 26.2 | 31% | 72,377 | 7.3% |
| 0.50% | 9.50% | 22.4 | 12% | 69,910 | 3.6% |
| 0.25% | 9.25% | 21.1 | 5% | 68,690 | 1.8% |
| -0.25% | 8.75% | 19.1 | -5% | 66,278 | -1.8% |
| -0.50% | 8.50% | 18.3 | -9% | 65,087 | -3.5% |
| -1% | 8.00% | 16.9 | -15% | 62,733 | -7.0% |
| -1.50% | 7.50% | 15.9 | -21% | 60,419 | -10.5% |
| -2.00% | 7.00% | 15.0 | -25% | 58,147 | -13.8% |
As you can see, even a cut of 2% reduced the loan tenure by only 5 years. Now, that’s not less, but I am not sure you want to wait for 15 years to close the loan. And even 15 years is assuming interest rates stay there.
| Interest Rate Change | Revised Interest Rate | Revised Loan Tenure (Years) (without changing EMI) | Prepayment (Reduced Tenure) (as a percentage of outstanding loan amount) | ||||
| 1% | 5% | 10% | 20% | 25% | |||
| 2% | 11.00% | NA | NA | 31.4 | 22.7 | 15.4 | 13.2 |
| 1.50% | 10.50% | 34.4 | 31.5 | 24.6 | 19.9 | 14.4 | 12.5 |
| 1% | 10.00% | 26.2 | 25.0 | 21.3 | 18.0 | 13.6 | 11.9 |
| 0.50% | 9.50% | 22.4 | 21.7 | 19.1 | 16.6 | 12.9 | 11.4 |
| 0.25% | 9.25% | 21.1 | 20.5 | 18.2 | 16.0 | 12.6 | 11.2 |
| 0.00% | 9.00% | 20.0 | 19.5 | 17.5 | 15.5 | 12.3 | 10.9 |
| -0.25% | 8.75% | 19.1 | 18.6 | 16.9 | 15.0 | 12.0 | 10.7 |
| -0.50% | 8.50% | 18.3 | 17.8 | 16.3 | 14.6 | 11.7 | 10.5 |
| -1% | 8.00% | 16.9 | 16.6 | 15.3 | 13.8 | 11.3 | 10.2 |
| -1.50% | 7.50% | 15.9 | 15.6 | 14.4 | 13.1 | 10.9 | 9.8 |
| -2.00% | 7.00% | 15.0 | 14.7 | 13.7 | 12.5 | 10.5 | 9.5 |
As you can see, with the tailwind of lower interest rates, you reduce loan tenures sharply. Perhaps, not as sharply. This also shows that if you want to close your home loans sooner, you might have to make even greater prepayments.
Now, you may not have this kind of money to spare for prepayments. Therefore, let’s also see how small excess payments every month can do to your loan tenure. This may not be practical as your bank may limit the number of prepayments you may make every year. Still, this gives an idea. We will assume that you pay a little bit more than your EMI every month.
| Interest Rate Change | Revised Interest Rate | Revised Loan Tenure (Years) (without changing EMI) | Paying a bit more than the regular EMI (Increasing monthly payment by below percentages) | ||||
| 1% | 5% | 10% | 20% | 25% | |||
| 2% | 11.00% | NA | NA | 32.1 | 23.8 | 17.3 | 15.4 |
| 1.50% | 10.50% | 34.4 | 31.5 | 24.9 | 20.6 | 15.9 | 14.4 |
| 1% | 10.00% | 26.2 | 25.0 | 21.5 | 18.5 | 14.8 | 13.6 |
| 0.50% | 9.50% | 22.4 | 21.7 | 19.2 | 17.0 | 14.0 | 12.9 |
| 0.25% | 9.25% | 21.1 | 20.5 | 18.4 | 16.4 | 13.6 | 12.6 |
| 0.00% | 9.00% | 20.0 | 19.5 | 17.6 | 15.8 | 13.2 | 12.3 |
| -0.25% | 8.75% | 19.1 | 18.6 | 16.9 | 15.3 | 12.9 | 12.0 |
| -0.50% | 8.50% | 18.3 | 17.8 | 16.4 | 14.8 | 12.6 | 11.7 |
| -1% | 8.00% | 16.9 | 16.6 | 15.3 | 14.0 | 12.1 | 11.3 |
| -1.50% | 7.50% | 15.9 | 15.6 | 14.5 | 13.4 | 11.6 | 10.9 |
| -2.00% | 7.00% | 15.0 | 14.7 | 13.8 | 12.8 | 11.1 | 10.5 |
Through these illustrations, I am not implying that low-interest-rate regimes are better times for prepayment. If you are keen on closing the home loan soon, it is better to prepay whenever you have excess capital available.
Do not wait for any opportune interest rate movements to reduce the loan amount. Waiting for an interest rate reduction before you start making loan prepayments would in fact be an insipid choice. Assuming your prepayment capital earns a low return in savings bank account or bank FD, you would want to utilize this capital for prepayment when the interest rates are high (because the difference between post-tax cost of loan and post-tax return on capital is higher).
In any case, you do not control interest rate cycles. You can only control prepayments.
Should You Prepay When the Interest Rates Are Low?
A counter argument to all that I have written above is: It is better to prepay when the interest rates are high. When the interest rates are low, the cost of capital is low and hence you can deploy capital elsewhere (rather than prepaying the loan) and try to beat the post-tax cost of the loan. This makes sense too. The threshold-return to beat to justify non-prepayment of loan is lower when the interest rates are low.
However, I do not want to go down that tangent. When the intent is to expedite loan closure, such portfolio optimization will take a backseat for most households. At the same time, I am not in favour of obsessing about home loan closure and putting everything else (other financial goals) on hold until you close the home loan. You must strike a balance.