Mumbai resident Nirav Shah (35) had taken a home loan of Rs 40 lakh in 2015 at an interest rate of 8.5% for a tenure of 30 years. Initially, he was paying a monthly installment (EMI) of Rs 31,000 and was following the amortization schedule. However, he soon realized that a large portion of his monthly income was going only towards loan repayment, impacting his other financial goals.
To find a solution to this problem, Nirav started working from the second year. loan prepayment Adopted the strategy of. Its objective was to reduce the tenure of 30 years and finish the loan in just 5 years. Many people like Nirav try to reduce the tenure of their home loan and reduce the interest burden with the help of prepayment.
The best way to save interest in the initial years
In the first few years of a home loan, a major portion of your monthly installment goes towards paying the interest only. If you make prepayment at this time, you can save huge in the long run. Pranav Gupta (32) from Ahmedabad, along with his wife, had taken a joint home loan of Rs 75 lakh at 8.5% interest rate. His loan tenure was 25 years, and he is paying EMI of Rs 60,392 every month.
When Gupta calculated the interest on his loan, he found that apart from the principal, he would have to pay Rs 1.06 crore as interest over a period of 25 years. If the interest rate had been 9% or 9.5%, the interest burden would have increased even more to Rs 1.14 crore or Rs 1.22 crore.
Adil Shetty, CEO, Bankbazaar.com Explains, “Prepayment of loan in the initial years is more beneficial, because at this time interest forms a major part of your EMI. “Prepayment reduces the principal amount, which cuts down on interest costs significantly.”
How is interest saved?
Suppose you have taken a loan of Rs 50 lakh for 20 years, the interest rate of which is 9% per annum. You will have to pay a total interest of Rs 58 lakh on this loan. But if you make a prepayment of Rs 5 lakh in the 13th month, the interest cost will reduce to Rs 40.4 lakh. That means, you will get a total saving of Rs 17.6 lakh.
However, if you make a prepayment of Rs 5 lakh in the 10th year (121st month), the interest savings will be only Rs 6.1 lakh. This means that the earlier you make prepayment, the more you will save.
Use extra income for home loan prepayment
It can be beneficial to utilize your bonus, tax refund, or other extra income to prepay the home loan. FPSB India CEO Krishna Mishra Says, “Putting extra income into prepayment directly reduces your principal amount. Its advantage is that the interest cost reduces and the loan tenure also reduces.”
From which sources prepayment can be made?
- Bonus: Use annual or performance based bonuses for loan prepayment.
- Tax Refund: Use the amount received from income tax refund in prepayment.
- Windfall Gain: Use it properly in case of sale of any property, gift or receipt of unexpected money.
However, experts advise not to use retirement funds like PF or pension fund for prepayment. By doing this your retirement planning May be affected and may lead to financial crisis in future.
Benefits of loan prepayment
- Huge interest savings:
Prepayment reduces the principal amount of your loan, which reduces interest costs.
- Reduction in loan tenure:
Prepayment may reduce your loan tenure. This reduces the burden of your monthly installment and provides quick relief from debt.
- Economic Freedom:
Making prepayments helps you become debt-free sooner, allowing you to put your income toward other financial goals like investing or buying property.
- Mental peace:
Becoming debt-free quickly reduces financial stress and can give you peace of mind.
Things to keep in mind while making prepayment
- Prepayment Penalty:
Many banks levy penalty charges on prepayment. Before making prepayment, get complete information about its rules from your bank.
- Maintain an emergency fund:
Don’t put all your extra income into prepayment. Save some money for emergencies.
- Reduce loan tenure:
Choose to reduce your loan tenure while making prepayment. This maximizes interest savings.
- Assess all options:
If you have any high-interest debt (like credit card debt), eliminate that first.
