Home loans, despite being a great help in purchasing a house, can also feel like a burden for many. Not all, but a large number of people do want to get rid of their home loans quickly.
And as I wrote earlier (Should you prepay home loans now) with home loan rates breaching 9 percent and being higher than what many safe debt instruments offer, there is a case to begin your prepayments if you can manage.
So, let’s take a quick and simple example to show how you can, without burdening yourself too much, close a 25-year home loan in a much shorter 10-year period. There are definitely many ways to prepay your home. But here, we choose the easiest ones to achieve the goal of clearing a 25-year loan in 10 years.
Also read | MC Explains: Why long-term home loans are not necessarily bad
Original (base) scenario of Rs 50 lakh loan for 25 Years
Suppose you took a home loan of Rs 50 lakh at 8.5 percent for a 25-year tenure. Your monthly EMI would be Rs 40,261. If you continue paying regularly without any prepayment, then your loan will be cleared off in 25 years as per schedule (assuming a rate of interest remains the same for simplicity in this example). But you will also end up paying a total interest of Rs 70-71 lakh in addition to repaying the Rs 50 lakh principal. And this is what pinches most people and drives them towards prepayment.
Now there are two parts to the prepayment strategy here.
Pay 1 extra EMI each year
Here is the first part of the strategy – Pay 1 month’s extra EMI each year. So, in our example, instead of 12 monthly EMIs of Rs 40,261 each year, you instead pay 13 EMIs. How does this help?
Doing this alone will bring down your tenure from 25 years to about 19-20 years. So, you shave off about 5+ years from the tenure. In addition, you also end up saving more than Rs 18 lakh in interest costs. Not bad, isn’t it?
For those who are running a tight (household financial) ship, this might seem difficult. But it is still a low hanging fruit considering that every year you might get some bonus/incentives. So, a part of that surplus can be used to make at least one extra EMI payment.
Tip - If making one full extra EMI payment in one go is difficult, then try to pay a few extra thousand every month so that across the year, the total prepayment is close to one EMI. So instead of a monthly EMI of Rs 40,261, if you pay a slightly larger, Rs 43-44,000 per month, even then it will have a similar impact.
Also read | India’s middle-class and the EMI conundrum: 4-step guide to reducing the home loan burden
Increase EMI by 7-10 percent each year
The second part of the strategy is – Increase your monthly EMI each year by 7-10 percent. Your income/ salary increases every year. So, you can very well increase your EMIs too (even if your bank didn’t ask you for it). So, if you started with Rs 40,261 monthly EMI in the first year. Now if you increase it by just 5 percent every year, then the 25-year loan will get over in about 14 years. And if you increase the EMIs by 7.5 percent, then your tenure reduces to about 12 years.
You have now seen how both these strategies help you a lot as a borrower.
Now magic happens when you combine them. That is,
Pay 1 extra EMI each year + increase EMIs by 7.5% each year
What is the outcome?
Your 25-year home loan gets over in just a shade above 10 years. And that is what we started with as our goal in the first place.
Tip – In some years, you may get a good hike (like a job switch) and in other years not so good. So, if you can, then consider increasing your EMI by the same or a similar percentage as your income increases every year.
As you can see, paying just one extra EMI each year and increasing your EMIs by a few thousand rupees each year isn’t very difficult. But just a small push from your side can really help you get over your home loan burden. Having said that, everybody’s situation is different and, hence, may require a different strategy. So, think about what’s the best approach for you and then follow it.
Let me end this discussion by reminding you that when it comes to loan math, prepaying is better than later.
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