Why you should prepay home loan now & ensure long term saving

Adhil ShettyRepaying any long-term loan needs financial discipline and patience. You have to pay EMIs which can take a large bit out of your disposable income. This is why we want to repay our debts as soon as possible. One way to do that is to go for principal pre-payments. At the moment, home loan interest rates are trending at their lowest in several years. After the SBI’s recent announcement to offer an interest rate of 8.65% its home loans, Bank of Baroda lowered its rate to 8.35%. Not only does this provide buyers a great chance to get a low-cost loan, it also offers a window of opportunity to existing loan holders to pre-pay on their outstanding loan balance and make great, long-term progress in getting out of debt. Pre-payment reduces your interest burden, reduces the tenor of your loan, and ensures long-term savings for you. But pre-paying becomes even more impactful when you do it while the interest rate is low. Let’s understand this in detail in this article. Impact of fall in interest rate on pre-paymentHome owners feel the burden of high interest outflows every month. A home loan is often the largest financial responsibility they will take in their lives. Often, property valuations look less lucrative due to the large interest payment on loans. Hence some people prefer to pre-pay their loans as quickly as they can. Making the pre-payment at the right time could help you save more. Instead of making small payments, accumulate your surplus cash and pre-pay on your loan when interest rates are low. Here’s why. Let’s say you have a home loan of Rs. 50 lakh for 20 years at 10.50 % (floating rate basis). Your yearly loan amortization schedule would look like this:Annual Amortization Schedule        As per this plan, your total interest outgo would be Rs. 6,980,559. Let’s say, you wish to make a prepayment of Rs. 2 lakh at the start of the fourth year. After the prepayment, your principal outstanding will be reduced to that effect. Next, your EMI or the tenor will be adjusted accordingly. Now, let’s consider two different interest rate scenarios to understand the impact of your pre-payment.Scenario 1 – The interest rate is unchangedYour loan balance before pre-paying Rs. 2 lakh with your 37th EMI is Rs. 4,740,280. Interest will be calculated on the remaining outstanding balance after the prepayment. This is how the interest outflow would look like from the fourth year.With the interest rate remaining the same, pre-paying Rs. 200,000 saved you Rs. 870,889. Scenario 2 – Interest rates falls down to 9% at the time of prepaymentNow, let’s assume that after 36 EMIs, the interest rate comes down to 9%. Your loan balance is Rs. 4,740,280 at the start of the 37th EMI when you decide to pay Rs. 200,000. In this scenario, you save a whopping Rs. 1,563,994 (6,980,559 – 5,416,565) on future interest payments. This is almost twice the savings from the first scenario where the rates had remained stagnant. When the interest rates start trending upwards in the future, you would have made tremendous progress with your loan repayment and the interest hike would not pinch you as much. ConclusionTo summarize, you will save heavily on interest payments if you make pre-payment at the right time. As there is no prepayment charges on floating rate loans, set aside surplus money every month and start prepaying when interest rates come down.The writer is CEO, BankBazaar.com