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Two key strategies to repay your home loan faster

Here's a surefire way to pay off your home loan faster and reduce your debt burden by leaps and bounds.

May 19, 2022 / 02:48 PM IST

For most of us, the biggest investment we make is our home. This is often where we begin to build wealth from. You've probably heard of someone from your office, or in your social circle who finished their home loan in record time. How do you think they did it?

Did you assume they had a teeny tiny home loan? Or that this person had financial help? Or that they lived a life of abstinence while they paid their home loan? Maybe they did. But you definitely don't have to. As long as you understand the maths behind Home Loans, slaying your home loan in record time is something you can boast of too!

Let's start with the basics. When it comes to repaying the loan, there are two concepts you need to get super familiar with: the principal and the interest.

What is the principal? In simple terms, the principal is the original amount you borrowed from the lender. That's it.

Interest on the other hand, is a little more complex. This is the amount you pay to the lender, over and above the principal, for the convenience of the loan. It is usually expressed as a percentage. Let's take a simple calculation of a loan of Rs 1 Lakh @8% for one year. At the end of the year, you need to pay back the original 1 Lakh, plus 8,000 (8% of 1 Lakh) to the lender.

How does it work for home loans? Let's use an example to understand this: say you've availed a home loan of Rs 50 Lakhs @8% floating interest, for a period of 25 years. For longer term loans like Home Loans, the rate of interest can be fixed or floating. Put simply, fixed rate loans carry a fixed interest rate throughout the tenure, whereas in floating rate loans, the interest rate fluctuates up and down. For this example, we'll use floating interest rates, as these loans allow the borrower complete flexibility in prepayments!

We're going to look at 2 key strategies here: making prepayments regularly, and increasing the EMI amount.

Without getting too deep into the calculations, for a home loan of Rs 50 Lakhs @8% floating interest, for a period of 25 years, you end up paying a principal of 50L and interest of 65.77L over 25 years with an EMI of Rs 38,590. Each month's EMI is made up of two aspects: interest charged on the remaining principal (i.e. interest on principal outstanding), and repaying the principal. This means, each month, as the principal outstanding reduces, and so does the interest. The highest interest payments happen in year 1, followed by year 2 and so on. As time goes on, the EMI contains more principal than interest!

In this example, in the first year, you pay:

 
EMI PaidPrincipal repaidInterest paidPrincipal remaining
5,11,54481,2124,30,33249,18,787

 

Despite paying over 5 Lakh rupees in EMIs, you have paid just under 2% of your principal! The good news: Prepayments on Home Loans generally carry zero penalty on floating rate home loans and making even small prepayments can make a huge difference.

Strategy A : Make prepayments

Let's look at a few different prepayment strategies. Let's say you got a bonus in the 10th month of your loan's first year. You choose to prepay an extra Rs 40,000. This is strategy A in the table below. Now, if you decide to do this every year, (at the same time each year, when you get your bonus!), that becomes Strategy A+ and you can see how much of a difference a regular prepayment (even just once a year!) makes!

 
Action TakenEMI & Tenure remaining (before)Interest saving (after)Tenure reduction (after)
Strategy A: Prepaid Rs 40,000 in Month 10

EMI: 38,590,

290 months remaining
Rs 229,3027 months
Strategy A+:  Prepaid Rs 40,000 in the 10th month of every year.

EMI: 38,590,

290 months remaining
Rs 15,29,97350 months

Should I shorten the tenure when I pay, or reduce the EMI?

This is a question you'll be asked at the bank, each time you prepay. Let's remember what the EMI is made up of. Each month, interest is calculated for the remaining principal, and the rest goes towards paying the principal amount. So when you reduce your EMI, you're essentially paying less towards your principal each month.

Now if you reduce your tenure, and keep your EMI the same, your principal remaining has just dropped by Rs 40,000. So, the following month, your interest will be charged on the remaining principal less the Rs 40,000 you prepaid! Shortening the tenure is an excellent way to repay your home loan quickly, and save what would have gone out as interest.

Strategy B: Increase EMI

Let's assume that in the example we've been using, that in addition to your bonus, you also get a pay raise at the end of 10 months. You have more money now, so you can pay more into their loan, right? Let's look at the maths: increasing your EMI by just Rs 1,000 in the first year is Strategy B, and increasing it each year (as you continue to grow your income) is Strategy B+
Action TakenEMI & Tenure remaining (before)Interest saving (after)Tenure reduction (after)
Strategy B: Increased EMI by Rs 1,000 in Month 10

EMI: 39,590,

290 months remaining
Rs 5,28,52220 months
Strategy B+:  Increased EMI by Rs 1,000 in the 10th month of every year

EMI: 38,590,

290 months remaining
Rs 20,12,68795 months

Increasing your EMI amount is a great way to shorten your loan tenure and save on what would have been paid away as interest.

So far, we've discussed two strategies: Prepayment and increasing your EMI. What if you combined both the approaches? Look no further, we've done the maths for you!

 
Action TakenEMI & Tenure remaining (before)Interest saving (after)Tenure reduction (after)
Strategy A & B applied together

EMI: 38,590,

290 months remaining
Rs 7,24,13626 months
Strategy A+ & B+ applied together

EMI: 38,590,

290 months remaining
Rs 26,47,706117 months (Yes, roughly, a third of the time!)

 

 

My home loan provider's website doesn't tell me how much principal is remaining… How do I plan this?

The home loan websites may not give you this information, as the lender wouldn’t want you to avail balance transfers, without having the opportunity to retain you first! So, this is where you can get creative. Use the OneScore app to check your credit report. Your monthly report shows you all your current outstanding balances. This includes your home loan principal outstanding!

 

Incidentally, balance transfers are an option if even small prepayments are beyond your budget right now. Competition among lenders is tight, and other banks and lenders will potentially offer you terms that might be more suitable. Who knows, your own lender may offer you better terms to retain you! Either way, you'll be paying less interest than you are now.

 

You can also request an amortisation chart from your home loan provider - this gives you a breakdown of the EMI each month over your loan's lifetime. However, just knowing the pending principal balance is enough for you to calculate how much interest you're paying this month. Once you know that, subtract it from your EMI amount to figure out how much principal you're paying back each month (at this point in time).

 

Don’t break the bank though!

While repaying a home loan through prepayments to become debt-free is ideal (and by now, quite tempting!), doing so should not undermine other financial goals like your emergency fund, children’s education fund, retirement goals, etc. Keep on top of all your loan payments and your credit score with the OneScore app; and each month, ask yourself #ScoreDekhaKya so nothing takes you by surprise!

For more articles, information and tips, visit our page #ScoreDekhaKya.

Moneycontrol journalists were not involved in the creation of the article.
Tags: #Features
first published: May 19, 2022 01:37 pm