Home loan

Why prepaying a home loan is a very good idea


Paying off a home loan early is the best thing a borrower can do. Most lenders won’t tell you this because they don’t make money unless you pay them interest. The smartest way to save money is to close your loans early, preferably through small, regular prepayments.

Basics of prepayment

When you take out a loan from a bank or a non-bank financial company (NBFC), it must be repaid in easy monthly installments (EMI).

The lender will deduct these EMIs from your bank account on a particular due date and all you have to do is maintain a sufficient balance in your bank account.

An EMI has two components, principal and interest. For example, if your NDE is 10,000, part of it is used to pay the interest on your loan and the rest is used to reduce your principal. This equation changes over time.

The interesting part is that the interest component is higher in the early years of the loan. This component keeps decreasing as you progress towards the end of your loan term.

How prepayment helps

Each time you prepay your loan, it directly contributes to reducing the amount of your outstanding principal. It is important. Big or small, any amount helps.

This means that your next month’s interest will be calculated only on the remaining principal amount, which results in two very important results. One, lower interest part and two, higher main part – in the next EMI.

This can help you significantly reduce the interest component for the remaining term of the loan and pay off the principal more quickly.

The end result of your prepayment is that you end up closing your loan much sooner than you originally thought.

So, prepayments are a very good idea, but often customers may not be aware of or forget to opt for these. Regularized advance micro-payments that are automatically debited from your bank account are therefore an option to consider.

Here is an example to understand how advance payments can make a difference.

Suppose you have taken out a loan of 20 lakh for a term of 20 years at an interest rate of 7.5%.

Scenario 1 – Your Monthly IME Reached 16 111. You end up paying 38.7 lakh after 20 years, which means your interest charges are around 18.7 lakh on a loan of 20,000,000. Now, when I say it that way, that sounds like a lot.

Scenario 2 – With a regular monthly prepayment of 1,000, you end up saving 2.66 lakh on your interest charges. This equals 29 NDEs. It’s like getting out of debt two years ago just by putting aside 1000 each month.

Prepayments, rather, regular prepayments are a superpower for any borrower.

Points to note

There are two things a borrower should consider before prepaying a home loan.

One, the fees involved in the prepayment. If you have taken out a variable rate loan, financial institutions cannot charge you for the prepayment of the loan. But, if you have opted for a fixed rate loan, there may be prepayment charges. So take note of that. Second, prepay the most expensive loan first.

For example, if you have a personal loan or auto loan in addition to a home loan, prepay the one with the highest interest outflow.

A home loan is a long-term commitment. When you decide to take it, choose your lender wisely. Ask them about prepayments and the policies around them. Make sure you can easily complete the prepayment transaction from your phone like you do everything else in your life.

Manoj Viswanathan is Managing Director and CEO of Home First Finance Company India.

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