How increasing your home loan EMI by Rs 5,000 can save over Rs 26 lakh in interest

Don't reduce the EMI

With the Reserve Bank of India (RBI) reducing the repo rate by 25 basis points (bps) on February 7, those who've taken home loans may be tempted to reduce their EMI, but they are better off leaving it unchanged. When rates go down, banks typically maintain the EMI (equated monthly instalment) amount and reduce the tenure, though one can insist on a lower EMI.

However, this would mean letting go of the opportunity to reduce the interest payable over the life of the loan. “To give you a simple example: say, you have a 20-year loan at 8.5 percent interest and have paid  12 EMIs by March. Now, when your interest rate drops to 8.25  percent from April, on a per lakh basis, you’ll save Rs 8,114 if you don't change your EMI (as the tenure will shrink), compared to Rs 3,472 if you reduce the EMI, as that won't shorten the tenure. That is, 133 percent higher savings in this case, which demonstrates the power of tenure adjustment,” says Adhil Shetty, CEO, BankBazaar.com.

Increase your EMIs

When rates go up, banks are mandated by the RBI (Reserve Bank of India)  to give borrowers the option to choose between higher EMIs, longer tenure, or a combination of both to adjust to the higher rates. In a falling rate scenario, it makes sense to reach out to your bank to increase the EMI or make a part-prepayment.

“Given the double bonanza of a repo cut and favourable tax rates, a borrower can easily increase the EMI by Rs 5,000, which will shorten the overall loan tenure to 208 months from the original 300 months (25 years), resulting in 92 fewer EMIs,” says Patel. That is, you will be able to pay off your loan in a little over 17 years rather than 25 years. This calculation assumes that a borrower had taken the Rs 50 lakh home loan just before the repo rate cut at an interest of 8.5 percent per annum. Post the repo revision, the interest is assumed to have dropped to 8.25 percent.

“(Starting from April) someone earning a gross salary of Rs 25 lakh will save around Rs 1.14 lakh a year due to lower taxes. These savings can be deployed towards an EMI hike, if getting out of debt quicker is an important goal for you,” adds Shetty.

Make part-prepayments out of annual bonuses

Many salaried employees receive pay hikes and annual performance bonuses around the start of the new financial year, which boosts their cash-in-hand. Make use of the additional funds to reduce your loan burden. “April being the season of bonuses and increments, you can also make a one-time part prepayment of Rs 50,000, which will shorten your tenure by another five months,” explains Patel. That is, if you were to hike your EMI by Rs 5,000 and make a part-prepayment of Rs 50,000, you will have to pay 97 fewer EMIs.

Also read: Home loan interest rates may drop: Here's how to maximise savings with prepayments

Even with part-prepayments, it is important to ensure that they are not sporadic but made in a systematic, planned manner. “Ideally, have a time-frame for getting out of debt. For instance, if your plan is to pay off a 25-year loan in 10 years, you should aim to pay back 10 percent of the loan balance every year through a combination of EMIs and pre-payments. you can ask your bank to send you an updated amortisation schedule and work out the math,” says Shetty.