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Home loan: To prepay or not to prepay?

As in any interest rate scenario, many people who have home loans are considering whether or not it is recommended to prepay their home loans so as to incur lower EMI payments going forward.

By Personal FN

As in any interest rate scenario, many people who have home loans are considering whether or not it is recommended to prepay their home loans so as to incur lower EMI payments going forward.

But before rushing into the decision, there are a few things to look into when considering home loan prepayment, and these are explained below:

1. Prepayment & Interest Savings

First, what is prepayment? Prepayment is when you decide to pay an additional (over and above your regular EMIs) amount of principal of your loan back, ahead of time. This reduces the principal outstanding, which in turn reduces your EMIs or your remaining loan tenure.

Banks typically levy a prepayment charge of about 2 - 3% of the outstanding loan amount, if you prepay above a certain amount, or if you are switching lenders. However as per recent NHB notification, this has been disallowed going forward. There are still some loans on which prepayment charges apply, so be sure to check with your lender.

At the very least, most banks will allow part prepayment up to a certain limit without levying on you any prepayment charge.
In some cases like with SBI, if the prepayment is out of your own income and not borrowed money, you can prepay any amount without incurring any penalty. You can opt to partly prepay your loan regularly, for example every 3 months, constantly reducing your principal outstanding, bringing down the amount of interest you will owe the bank. Remember, the longer the tenure of the loan, the more the interest you are paying, so part prepayments are a good way of saving on interest payments.

An illustration will help explain the point:

Our favourite fictional character, Mr. Shah has taken a loan 5 years ago, and wants to reduce his debt burden by making part prepayments.

Initial Loan Taken Rs. 20 lakh
Tenure of Loan 20 years
Loan tenure elapsed 5 years
Current EMI Rs. 22,022
Current interest rate 12% p.a.






If Mr. Shah were to continue with his EMIs, he would repay the following amounts:

Total interest payment (nominal value) Rs. 21.29 lakhs
Total Principal Repaid (outstanding principal) Rs. 18.35 lakhs





(These figures can be arrived at from the amortization table in his loan policy document which his bank has to provide to him.)

Thus, his Rs. 20 lakh loan would cost him approximately Rs. 40 lakh over 20 years, assuming a constant interest rate of 12% for the sake of calculations.
Understandably, Mr. Shah wants to reduce the debt burden.

He can save enough through the year by cutting down his expenses and channelizing his bonus towards home loan prepayments, to pay an additional 3 EMIs every year.

If he does so his payments come down to:

Total interest payment (nominal value) Rs. 12.03 lakhs
Total Principal Repaid (outstanding principal) Rs. 18.35 lakhs





He saves approximately Rs. 9 lakhs in interest payments - Certainly a tidy sum!

Also remember, any prepayments towards home loan will be considered for tax benefit under Section 80C as they are repayment of principal of the home loan - an added benefit!

Additionally, by doing so, he would not incur any prepayment penalty as this is below the maximum penalty incurring limit levied by his bank, and he can reduce his loan tenure by close to 6 years. He can repay his total loan in approximately 14 years instead of 20.

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