Most people find emotional fulfilment in the idea of owning a debt-free home, especially if it is their primary residence. So they often choose to prepay their home loan if they have any extra funds available.
Prepayment refers to paying back a loan early. People with extra money frequently choose to prepay their loan. It's because prepayment reduces the overall interest component that is built up throughout the initial stages of a loan.
What happens if you prepay a part of your loan?
Let us try to understand it with the help of an example.
Consider a home loan of ₹1 crore with a 30-year repayment period and an interest rate of 7% p.a. You decide to prepay an amount of 2 lakhs at the end of third year.
| With prepayment | Without prepayment | |
| Principal amount | 1 crore | 1 crore |
| Prepaid amount | 2 Lakhs | Nil |
| Total Interest paid | 1.29 crores | 1.39 crores |
| Total amount paid | 2.29 crores | 2.4 crores |
| Amount saved | 11 lakhs | Nil |
Source: The above data has been taken from https://www.financialexpress.com/
You can therefore shorten the length of your loan and save about ₹11 lakh by making only ₹2 lakh in prepayments.
It might be a good idea to make as many part-prepayments as you can when the applicable home loan interest rates are low and your credit score is high because floating rate home loans could see a hike due to interest rate revisions or a significant drop in the borrower's credit score at any time during the loan tenure.
On house loans with floating rates, neither banks nor housing finance companies (HFCs) impose any prepayment penalties. Simple interest will incur a modest fee, which can also be reduced by completing the prepayment early in the month. However, for fixed rate house loans, lenders have the option to impose a prepayment penalty of about 2% of the amount prepaid.
However, it is important to note that, you won't be able to take advantage of the different tax benefits offered to borrowers if you prepay a loan. For a self-occupied home, you are permitted to claim the interest payments as deductions totaling up to ₹2 lakh per fiscal year. Furthermore, you are eligible to claim a tax exemption of up to Rs. 1.5 lakh on the principal payments for each fiscal year. The given tax liberties will be removed if prepayment is made.
To lessen the total financial burden, it is wise to make partial prepayments on the house loan in addition to the monthly EMIs. However, talk through the terms and circumstances with the bank before choosing prepayment. For more help, you might perhaps speak to a financial expert about the situation.
