In August 2023, some banks increased their Marginal Cost of Funds Based Lending Rate (MCLR). These include HDFC Bank, ICICI Bank, Bank of Baroda, Canara Bank, Bank of India, etc. With the increase in MCLR, the interest rates on loans linked to MCLR, including home loans, will go up. The increase in home loan interest rates will further increase the financial burden on borrowers.
The RBI has increased the Repo Rate by 250 basis points from 4% to 6.5% in the last couple of years. It has pushed home loan interest rates to multi-year highs. Borrowers will end up paying higher EMIs on home loans, pinching their pockets further in a high inflation scenario.
Currently, most banks have home loan interest rates in the 8 to 10% p.a. range. Let us take an example. Suppose you have taken a 20-year home loan of Rs. 50 lakhs at an interest rate of 9% p.a. The EMI will be Rs. 44,986. The total interest outgo will be Rs. 57.96 lakhs over the 240 EMIs.
Let us discuss some home loan repayment options that you can consider to finish your home loan earlier than scheduled, giving the much-needed relief from EMIs.
Using the annual bonus to make a lumpsum prepayment
You can use your annual Diwali bonus or appraisal bonus to make a lumpsum prepayment every year. Suppose you make a prepayment of Rs. 50,000 every year. If we take our earlier example, the home loan will get over in 16 years 3 months (195 EMIs) instead of the original tenure of 240 months.
So, you will finish the home loan repayment around 4 years ahead of schedule. The interest outgo will be Rs. 45.41 lakhs instead of Rs. 57.96 lakhs, resulting in interest savings of Rs. 12.55 lakhs.
If you make an annual prepayment of Rs. 1 lakh, the loan will be in around 14 years (6 years ahead of schedule). Also, the interest outgo will be Rs. 37.79 lakhs, resulting in interest savings of Rs. 20.17 lakhs.
Increasing the EMI by 5 to 10% every year
You can increase your EMI by 5 to 10% every year. Suppose you increase your EMI by 5% every year in our example. The EMI will be as follows: 1st year EMI – Rs. 44,986, 2nd year EMI – Rs. 47,236, 3rd year EMI – Rs. 49,597, 4th year EMI – Rs. 52,077, and so on.
In this case, the loan repayment will get over in 12 years and 1 month (145 EMIs) instead of the original tenure of 240 months. So, you will finish the home loan repayment around 8 years ahead of schedule. The interest outgo will be Rs. 36.53 lakhs instead of Rs. 57.96 lakhs, resulting in interest savings of Rs. 21.43 lakhs.
If you increase the EMI by 10% every year, the loan will get over in around 9.5 years (10.5 years ahead of schedule). Also, the interest outgo will be Rs. 29.37 lakhs, resulting in interest savings of Rs. 28.59 lakhs.
Every year, your income will increase. Increasing your annual EMI in proportion to the increase in annual income should be sustainable. However, after the first few years of increase in EMI, if you feel increasing the EMI further will strain your finances, you can keep the EMI constant.
Start a recurring deposit every year and use maturity proceeds for prepayment
Not everyone gets the Diwali bonus or annual bonus. In such a scenario, an individual can open a recurring deposit with the bank and contribute a specified amount monthly. For example, an individual can deposit Rs. 5,000 every month in a recurring deposit for a year. On maturity, the Rs. 60,000 plus interest can be used for home loan prepayment.
You can follow this recurring deposit process every year for home loan prepayment. It will help you finish the loan much before the original schedule and also help in saving a lot of interest amount.
Pay an additional EMI or a couple of EMIs every year
In the above section, we have seen how the annual prepayment of Rs. 50,000 or Rs. 1,00,000 can help finish the loan before schedule and reduce the interest payment. The other option is to pay one extra EMI every year. So, in a year, you can pay 12 regular EMIs and one additional EMI as prepayment. It will help finish the loan before schedule and reduce the interest payment.
If possible, you can pay multiple additional EMIs every year as prepayment instead of one additional EMI. The higher your prepayment amount every year in the form of additional EMI(s), the sooner your loan will get over and the higher the interest savings.
Please note that for simplicity of calculations, in our example, we have assumed the interest rate will remain constant throughout the 20-year tenure. However, in reality, most home loans have a floating interest rate. Hence, every time there is a change in the interest rate, the bank will either change the borrower's EMI or home loan tenure. Accordingly, all the future calculations will change.
Prepay your home loan and enjoy peace of mind
Buying a dream house is a once-in-a-lifetime decision for many individuals. Also, most people buy their dream house by taking a home loan. In a high interest rate scenario, the higher tenure or higher EMIs can strain the individual's finances. However, if you plan well, you can repay the home loan before its original term, save on interest, and enjoy the much-needed peace of mind.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.