Every home loan borrower wants to close the home loan quickly. After all, you truly own your house once you have repaid the entire home loan.
How Does the Home Loan Amount Go Down?
We know how loan mathematics works. Most home loans are reducing balance loans.
With reducing balance loans, a portion of EMI goes towards interest payment and the rest goes towards principal repayment.
Now, the interest component depends on the interest rate and the outstanding principal. And since the outstanding principal is higher during the initial years, the interest component of the EMI is also high. Since the interest component is high, the principal repayment component is low. That’s why the principal outstanding goes down very slowly during the initial years.
Gradually, as the principal outstanding goes down, the interest payment component of EMI comes down and principal repayment becomes faster.
Here is a breakdown of the amortization schedule of a Rs 50 lacs loan at 8% for 20 years.
At the end of the 1st year, even though you have paid 5% of EMIs, your principal outstanding will go down by 2.1%.
| Month | Loan outstanding at the start of the Month | EMI | Interest Payment | Principal Repaid | Loan O/S at the end of the month | % Principal Repaid |
| 1 | 5,000,000 | 41,822 | 33,333 | 8,489 | 4,991,511 | 0.170% |
| 2 | 4,991,511 | 41,822 | 33,277 | 8,545 | 4,982,966 | 0.171% |
| 3 | 4,982,966 | 41,822 | 33,220 | 8,602 | 4,974,364 | 0.172% |
| 4 | 4,974,364 | 41,822 | 33,162 | 8,660 | 4,965,704 | 0.173% |
| 5 | 4,965,704 | 41,822 | 33,105 | 8,717 | 4,956,987 | 0.174% |
| 6 | 4,956,987 | 41,822 | 33,047 | 8,775 | 4,948,212 | 0.176% |
| 7 | 4,948,212 | 41,822 | 32,988 | 8,834 | 4,939,378 | 0.177% |
| 8 | 4,939,378 | 41,822 | 32,929 | 8,893 | 4,930,485 | 0.178% |
| 9 | 4,930,485 | 41,822 | 32,870 | 8,952 | 4,921,533 | 0.179% |
| 10 | 4,921,533 | 41,822 | 32,810 | 9,012 | 4,912,521 | 0.180% |
| 11 | 4,912,521 | 41,822 | 32,750 | 9,072 | 4,903,449 | 0.181% |
| 12 | 4,903,449 | 41,822 | 32,690 | 9,132 | 4,894,317 | 0.183% |
For a detailed understanding of how loan mathematics works, refer to this post.
The Longer the Tenure, the Gradual the Decline in Outstanding Principal
As Expected. When the tenure is longer, the EMI is lower.
For instance, The EMI for a Rs 50 lacs loan at 8% will be as follows for these tenures.
- 20 years: Rs 41,822
- 25 years: Rs 38,590
The EMI is lower for longer tenure, but the interest cost is the same since the starting principal and interest rate are the same. Thus, if the tenure is longer, an even bigger portion of the EMI goes towards interest payment. And less towards principal payment. Hence, the principal goes down slowly.
For instance, for a 20-year loan, you repay Rs 8,489 of the principal amount in the first month.
For a 25-year loan, you repay only Rs 5,257.
Here is the amortization schedule for Rs 50 lacs loan at 8% for 20 years.
| Year | Loan outstanding at the start of the Year | EMI | Interest Payment during the year | Principal Repaid during the year | O/S principal at the end of the month | % Principal Repaid |
| 1 | 5,000,000 | 41,822 | 396,181 | 105,683 | 4,894,317 | 2.1% |
| 2 | 4,894,317 | 41,822 | 387,409 | 114,455 | 4,779,862 | 2.3% |
| 3 | 4,779,862 | 41,822 | 377,909 | 123,955 | 4,655,907 | 2.5% |
| 4 | 4,655,907 | 41,822 | 367,621 | 134,243 | 4,521,664 | 2.7% |
| 5 | 4,521,664 | 41,822 | 356,479 | 145,385 | 4,376,279 | 2.9% |
| 6 | 4,376,279 | 41,822 | 344,412 | 157,452 | 4,218,827 | 3.1% |
| 7 | 4,218,827 | 41,822 | 331,344 | 170,520 | 4,048,307 | 3.4% |
| 8 | 4,048,307 | 41,822 | 317,191 | 184,673 | 3,863,634 | 3.7% |
| 9 | 3,863,634 | 41,822 | 301,863 | 200,001 | 3,663,633 | 4.0% |
| 10 | 3,663,633 | 41,822 | 285,263 | 216,601 | 3,447,031 | 4.3% |
| 11 | 3,447,031 | 41,822 | 267,285 | 234,579 | 3,212,453 | 4.7% |
| 12 | 3,212,453 | 41,822 | 247,815 | 254,049 | 2,958,404 | 5.1% |
| 13 | 2,958,404 | 41,822 | 226,729 | 275,135 | 2,683,269 | 5.5% |
| 14 | 2,683,269 | 41,822 | 203,893 | 297,971 | 2,385,298 | 6.0% |
| 15 | 2,385,298 | 41,822 | 179,162 | 322,702 | 2,062,596 | 6.5% |
| 16 | 2,062,596 | 41,822 | 152,378 | 349,486 | 1,713,109 | 7.0% |
| 17 | 1,713,109 | 41,822 | 123,370 | 378,494 | 1,334,616 | 7.6% |
| 18 | 1,334,616 | 41,822 | 91,956 | 409,908 | 924,707 | 8.2% |
| 19 | 924,707 | 41,822 | 57,933 | 443,931 | 480,777 | 8.9% |
| 20 | 480,777 | 41,822 | 21,087 | 480,777 | 0 | 9.6% |
Amortization schedule for Rs 50 lacs loan at 8% for 25 years
| Year | Loan outstanding at the start of the Year | EMI | Interest Payment during the year | Principal Repaid during the year | O/S principal at the end of the month | % Principal Repaid |
| 1 | 5,000,000 | 38,591 | 397,635 | 65,455 | 4,934,545 | 1.3% |
| 2 | 4,934,545 | 38,591 | 392,202 | 70,888 | 4,863,657 | 1.4% |
| 3 | 4,863,657 | 38,591 | 386,318 | 76,772 | 4,786,885 | 1.5% |
| 4 | 4,786,885 | 38,591 | 379,946 | 83,144 | 4,703,742 | 1.7% |
| 5 | 4,703,742 | 38,591 | 373,045 | 90,045 | 4,613,697 | 1.8% |
| 6 | 4,613,697 | 38,591 | 365,572 | 97,518 | 4,516,179 | 2.0% |
| 7 | 4,516,179 | 38,591 | 357,478 | 105,612 | 4,410,567 | 2.1% |
| 8 | 4,410,567 | 38,591 | 348,712 | 114,378 | 4,296,189 | 2.3% |
| 9 | 4,296,189 | 38,591 | 339,219 | 123,871 | 4,172,318 | 2.5% |
| 10 | 4,172,318 | 38,591 | 328,937 | 134,152 | 4,038,165 | 2.7% |
| 11 | 4,038,165 | 38,591 | 317,803 | 145,287 | 3,892,878 | 2.9% |
| 12 | 3,892,878 | 38,591 | 305,744 | 157,346 | 3,735,533 | 3.1% |
| 13 | 3,735,533 | 38,591 | 292,684 | 170,405 | 3,565,127 | 3.4% |
| 14 | 3,565,127 | 38,591 | 278,541 | 184,549 | 3,380,578 | 3.7% |
| 15 | 3,380,578 | 38,591 | 263,223 | 199,866 | 3,180,712 | 4.0% |
| 16 | 3,180,712 | 38,591 | 246,634 | 216,455 | 2,964,257 | 4.3% |
| 17 | 2,964,257 | 38,591 | 228,669 | 234,421 | 2,729,836 | 4.7% |
| 18 | 2,729,836 | 38,591 | 209,212 | 253,878 | 2,475,958 | 5.1% |
| 19 | 2,475,958 | 38,591 | 188,140 | 274,949 | 2,201,008 | 5.5% |
| 20 | 2,201,008 | 38,591 | 165,320 | 297,770 | 1,903,238 | 6.0% |
| 21 | 1,903,238 | 38,591 | 140,605 | 322,485 | 1,580,753 | 6.4% |
| 22 | 1,580,753 | 38,591 | 113,839 | 349,251 | 1,231,502 | 7.0% |
| 23 | 1,231,502 | 38,591 | 84,851 | 378,239 | 853,264 | 7.6% |
| 24 | 853,264 | 38,591 | 53,457 | 409,632 | 443,632 | 8.2% |
| 25 | 443,632 | 38,591 | 19,458 | 443,632 | – | 8.9% |
A quick comparison.
| Percentage loan amount repaid. Rs 50 lacs at 8% p.a. | ||
| Years | Loan Tenure 20 years | Loan Tenure 25 years |
| 1-5 | 12.5% | 7.7% |
| 6-10 | 18.6% | 11.5% |
| 11-15 | 27.7% | 17.1% |
| 15-20 | 41.3% | 25.5% |
| 20-25 | – | 38.1% |
| Total | 100.0% | 100.0% |
The Higher the Interest Rate, the Gradual the Decline in Outstanding Principal
Again, as expected. Everything being the same, if the interest rate is higher, a bigger portion of EMI will go towards the interest payment and less towards principal repayment.
Rs 50 lacs loan for 20 years.
At 8% p.a.: EMI is Rs 41,822. In the first month, principal repayment = Rs 8,489
At 9% p.a.: EMI is Rs. 44,986. In the first month, principal repayment = Rs 7,486
| Percentage loan amount repaid. Rs 50 lacs loan for 20 years | |||
| Years | At 8% p.a. | At 9% p.a. | At 10%p.a. |
| 1-5 | 12.5% | 11.3% | 10.2% |
| 6-10 | 18.6% | 17.7% | 16.8% |
| 11-15 | 27.7% | 27.7% | 27.6% |
| 15-20 | 41.3% | 43.3% | 45.4% |
| Total | 100.0% | 100.0% | 100% |
The above analysis is with the assumption that the interest rate won’t change during the tenure. As the interest rate goes up, the principal repayment would slow down.
Expedite Loan Closure through Prepayments
Your home loan is closed when the principal outstanding goes down to zero. You can let home loan run down at its own sweet pace. Or you can aggressively reduce principal by making regular prepayments. The math behind prepayments is very clear.
Firstly, the outstanding principal goes down by the prepayment amount. Secondly, lower loan amount outstanding = Lower interest component of EMI = Higher principal component of EMI. This sets off a domino effect.
For instance, in a Rs 50 lacs loan at 8% p.a. for 20 years, the loan outstanding at the end of the 1st year will be Rs 48.94 lacs. 228 months still left in the loan. If you prepay the loan by Rs 5 lacs at the end of 1st year, the loan gets repaid in the next 182 months (a total of 194 months). You save a total of 46 EMIs.
Additionally, given the way the loan mathematics works, the sooner you prepay, the more you will save.
For instance, if you were to prepay loan by Rs 5 lac at the end of 5th year (instead of 1st year), the loan will finish in a total of 205 months. You save 35 EMIs.
The Most Basic Rule of All
An 8% loan (assuming no change in interest rate) remains an 8% loan irrespective of how or if you make any prepayments. The monthly payment (EMI) is fixed. Interest component depends on the interest rate (let’s say 8%) and the principal outstanding.
You make a prepayment. Principal outstanding goes down. Next month, the interest component will be lower because the principal outstanding has gone down. But you still pay 8% on the reduced principal. Prepayments do not change the overall cost of your loan.
By making prepayments, you only reduce the nominal (absolute) interest outgo. This might give you the impression that you have saved on interest. Yes, you have but you could have invested the prepayment amount and earned returns. If you earned more than 8% on your investment, you would have been better off than prepaying. Classic prepay or invest question. However, let’s not go there.
The intent is not to suggest whether home loan prepayment is a good or bad choice. This is just to dispel the notion that you save on interest costs. You save only the nominal interest costs. The percentage cost of loan does not change because of prepayment.
Home Loan prepayment is clearly a simpler choice. Whether investing (instead of prepaying) would have been a better choice or not? This can only be known in hindsight.
Product Innovation
Home loans do not have to be reducing balance loans. There is no regulatory requirement. There are loan products such as Axis Quick Pay where you pay equal amount of principal with each monthly installment. With such loans, the loan outstanding goes down at a brisker pace in the initial years. At the same time, the monthly payments are also high in the initial period.