Is Prepayment of Home Loan a good option?

These days the prices of Real estate are so high that home loan becomes an obvious thing, if you are planning to buy your dream home.

But have you ever think that prepayment of home loan is a good idea or not and whether it would be beneficial to you in the long run?

Here in this article, I will explain various scenarios based on which you will be able to realize that prepayment will surely leads to huge benefits in the long run.

Scenario:

Let’s take an example where Mr. A has taken a loan of 60Lakhs for his home at a floating rate of 11% for 20 years tenure. His monthly EMI would be Rs.61,931. Thus he would end up paying Rs. 1,48,63,440 at the end of 20 years which include the interest payment of Rs. 88,63,440.

The below chart shows the Principal and Interest payment over next 20 years. The green portion of the chart represents the Interest payment and blue represents the principal payment.

Now what will happen to your loan if you prepay 1Lakh at the end of one year? This will reduce the amount outstanding to Rs. 5835274 and thus the total interest paid by you now will be 76,07,880.  Thus you end up saving a whopping 12Lakh Rs. just by making prepayment of Rs. 1Lakh

Whenever you make a prepayment, you have two options:

1.    Keep the EMI same and reduce the Tenure,
2.    Keep the tenure same and reduce the EMI.

So which one is better out of these two? Let’s consider our earlier example only and evaluate the scenario.

·        -  If you keep the EMI same and reduce the tenure, the effective tenure would now be 18 Year and 1 Month. The total interest paid till the end of loan tenure is 76,07,880.

·        - If you keep the tenure same and reduce the EMI, your new EMI would be Rs. 60,383. The total interest paid till the end of loan tenure in this case would be 86,41,920,  means a saving of Rs. 2Lakh.

Thus it is always advisable to keep your EMI same and reduce the loan tenure to reap the extra benefits.

There is one more scenario – whether to prepay on a regular basis or to prepay a minimum amount (keeping the EMI same)?

Let’s suppose you continually prepaying 1Lakh for 5 years and in another case you prepay 5Lakh at the end of fifth year. Now which one would be better?

·       - In first scenario where you will be prepaying on a regular basis, the total interest paid by you till the end of loan tenure will be 60Lakhs.

·       - In the second case where you prepay 5Lakh at the end of Fifth year, the total interest paid by you till the end of loan tenure will be 64Lakhs.

Hence it is obvious that making regular prepayments is much more beneficial than making lump sum payment.

Therefore, it is always favorable to make prepayment of your home loan whenever you have surplus cash available with you and to maintain the EMI at the same time. Since Interest is always calculated on outstanding loan amount, repaying will reduce the same and therefore lowering the interest amount payable.

Hope this article will make some changes in your financial life and will help you to understand the benefits associated with Prepayment.