Who does not want to prepay a home loan early? By prepaying your home loan, you take a big liability off your back. This also ensures emotional and financial security for the family. The problem is that, for most middle-class families, the home loan amount is a multiple of their annual incomes. And you would not come across such big amounts very often. Hence, prepaying the entire home loan at one go is a stretch for most of us.
However, as they say, little drops of water make the mighty ocean. You do not have to wait for one big payout to reduce your home loan tenure. You can do that by paying a little extra every month and we will see how paying a little bit extra over and above your EMI every month can bring down loan tenure.
Please understand this may not be the most practical approach. Making frequent prepayments can be an operational challenge. The idea is to demonstrate the difference even small payments can make.
Let’s make a few assumptions first.
- Loan Amount of Rs 50 lacs, Interest Rate of 8% per annum, Loan Tenure of 20 years.
- The interest rate for the loan remains constant during the loan tenure.
- Monthly prepayments are permitted. The banks usually limit the number of prepayments in a year. However, you can navigate around this issue. So, if your bank permits prepayment once every quarter, you can accumulate the extra payment amount every month in your bank account or in a liquid fund and use it to make the prepayment once every quarter.
The EMI for the loan will be Rs 41,822. If you pay 1% more every month (Rs 418 more every month), the loan tenure goes down by five months from 240 months to 235 months.
How Does Loan Tenure Get Reduced?
This entire excess goes towards principal prepayment, reducing the loan outstanding at the end of the month (compared to the original amortization schedule). By doing this, you achieve two things.
- Since the outstanding principal is less than as per the original amortization schedule, the interest portion of the EMI in the next month also goes down, increasing the principal repayment portion of the EMI.
- Over and above, you are making extra payments, all of which goes towards principal repayment.
And this cycle goes on. With this, the principal gets repaid faster and loan tenure comes down.
Let’s see how these minor excess repayments can affect the loan tenure. If you pay 2% extra, the lone tenure falls to 229 months. If you pay 5% extra, the lone tenure falls to 215 months. I produce a table showing the reduction in loan tenure for various levels of excess payments every month.
|Monthly Excess Payment||Revised Loan Tenure||Reduction in Loan Tenure|
I understand paying 10 to 20% extra may not be possible every month. And you may feel, for anything less, the impact is not really meaningful. For instance, if you pay 5% extra every month, the loan tenure falls by just 2 years from 20 years to 18 years. Not really a big deal.
That’s right, but you just don’t have to limit yourself to this approach. You can use a portion from your next annual bonus or insurance policy maturity proceeds to make further prepayments.
For instance, if, along with 5% prepayment every month, you were to prepay 1% of the principal every 12 months, the loan gets over in 179 months.
- Only 5% monthly extra payment (over EMI), the loan gets repaid in 215 months.
- Only 1% (of original loan amount) repayment every year, the loan gets repaid in 195 months.
- If you use both the methods together, the loan gets repaid in 179 months.
The loan mathematics remains the same. For the loan tenure to come down, you must make prepayment (assuming interest rate remains constant). Now, it is a question of tuning your plan with your cash flows. And it is not an either-or approach.
Editor’s Note: Use our Home Loan EMI Calculator with Extra Payments to understand the impact of prepayments on your loan tenure.
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