How partial prepayments help
An EMI factors in both interest and principal payments. Higher the outstanding principal, higher the interest part in an EMI. If you can bring down outstanding principal, the interest part will come down and the principal repayment will be higher. This is what a partial repayment does. “A prepayment is counted only against the principal. You can devise a prepayment plan to pay off your loan quicker,” says Adhil Shetty, CEO, Bankbazaar.com.You need not necessarily make a big partial prepayment as even small ones can make a significant difference. “If you borrowed Rs 50 lakh at 7% for 20 years, your interest is going to be 43.03 lakh and your EMI, Rs 38,765. If you pre-pay a single EMI right at the start of the loan, your loan tenure reduces by three months and your interest by Rs 1.15 lakh,” says Shetty.
Imagine the impact if you make many such partial prepayments.
Things to keep in mind when planning a partial prepayment strategy
While there is no prepayment penalty on partial prepayment of a floating rate home loan, the rules regarding minimum prepayment amount will vary depending on the lender. “You can pre-pay as much as you want, subject to the lender’s conditions on the minimum prepayment amount,” says Shetty.If borrowers get very ambitious with the partial prepayment, it can put their finances under stress in case of an eventuality. It may even make it difficult for them to even continue paying the regular EMI. On the other hand, a very small prepayment will not do any meaningful contribution towards bringing down the interest outflow. “The key is to find a balance between getting out of the debt and balancing your savings and investment needs,” says Shetty.There are various ways in which borrowers can plan their prepayment after assessing their requirements. “You have the following options to speed up early closure of your loan: The first is pre-paying one extra EMI every year; second is pre-paying 5-10% of the loan every year and lastly, pre-paying 5-10% of the loan balance every year,” says Shetty.
Prepayment strategies for best saving on a Rs 40-lakh home loan
Original home loan tenure 20 years and interest rate 9.5%, All annual partial prepayments are made at the beginning of each year
Let us assume you have a Rs 40-lakh home for 20 years at an interest rate of 9.5% with EMI of Rs 37,285. You decide to prepay just one additional EMI at the beginning of each year. This will save you Rs 11.73 lakh as you will pay a total interest of Rs 37.75 lakh, instead of Rs 49.48 lakh. You will also pay off your home loan in 16 years 1 month, instead of 20 years.
If you decide to increase your EMI by 10% — from Rs 37,285 to Rs 41,014 — it will save you Rs 16.89 lakh on interest payment and your loan will be paid off in 14 years and 1 month, instead of 20 years.
Similarly, if you decide to make a partial prepayment of Rs 50,000 a year, you can save Rs 14.47 lakh on interest payment and close the loan in 15 years, instead of 20 years.
Bulk prepayment or small but regular prepayment: Which works better?
If the borrower’s income is limited, especially during the initial years of the home loan, the scope of making small regular prepayment may be less. “Pre-payments to your loans can be done as and when you have liquidity. This can be through increasing income, annual bonuses, business windfall or any other income that helps reduce the loan balance. You can pre-pay in the form of a lump sum or by increasing your EMI,” says xxx.
Some may have to wait for their income to increase or for some windfall gains. “As your income rises with time, increasing your EMI provides you an easy way to pre-pay. The amount you pay over and above the normal EMI will be adjusted against the principal, thus accelerating your journey out of debt,” says Shetty.
Is increasing the EMI a better option?
While taking a home loan, most borrowers go for the highest possible home loan amount. Therefore, the EMI becomes bigger. This would eat into their income and narrow the scope of increasing EMIs in the initial years. However, borrowers can consider a systematic pre-payment plan as their income level rises. “A systematic pre-payment plan (SPP) allows you to maximise the impact of prepayment while keeping the costs of prepayment at an optimal level, and still helping you get out of debt,” adds Shetty. Raising your EMIs also works as systematic pre-payment, and it gives you one of the best ways to pay off your home loan quickly.