scorecardresearchWhy must you consider prepaying your home loan

Why must you consider prepaying your home loan

Updated: 27 Apr 2022, 07:53 AM IST

Prepaying the home loan means that you are paying an additional amount over and above the regular EMIs after a certain point in time that goes towards reducing the principal loan amount. This has a corresponding reducing effect on the interest to be paid and the loan repayment period too. 

Prepaying your home loan

Prepaying your home loan

How many times have we thought of getting rid of our debts and liabilities quickly? This includes the need to repay our home loans and then focus on other aspects of our investments. Home loan is one of the most common debts that people have in their investment portfolio. Striking off this debt quickly is not easy considering the amount of loan taken for prolonged tenures in most cases. However, you must not underestimate the benefit of prepaying a home loan to lessen the effect of debt in the long run, thus, making it easy to repay the same quickly.

If asked the smartest way to save money, opt to close your debts quickly by preferring to close your loans quickly through small and regular prepayments. Irrespective of whether you take a loan from a bank or a non-banking financial company (NBFC), you must repay the same through easy monthly instalments (EMIs) spread over a pre-determined tenure. Many people have limited knowledge about the loans they take. All they realize is that they have secured a certain amount in lieu of collateral. The lender would then deduct EMIs from the bank on a predetermined amount. The borrowers must maintain sufficient balance in their accounts to avoid the penalty for missing out on paying their EMIs.

Not many understand that the EMIs they are paying regularly contain two components, viz. the principal and the interest whose composition change over time. A part of the EMI that you pay goes towards the interest while the remaining goes towards reducing the principal. The equation changes over time with a greater proportion of the EMI used to lower the principal component while the remaining is paid towards the interest charged. The interest component that is higher towards the initial years is considerably lower than charged in the later years. Only a small percentage of the principal amount gets repaid during the initial years while a much larger amount is left to be repaid during the remaining loan tenure.

If you are raising a home loan, you should take care of these factors.

Prepayment of the loan at regular intervals ensures a major chunk of the principal amount gets repaid faster, thus, having a mitigating effect on the interest component too. This means that you repay the loan much earlier than you had thought. Not many borrowers are aware of the prepayment facility or ignore this idea as another hogwash by financial institutions. To put this into effect, borrowers may consider regularizing micro-payments that are then auto-debited from the bank accounts.

The concept of prepayment can be explained with the help of the following example

Principal loan amount: 25 lakh

Interest rate: 8 per cent per annum

Loan tenure: 120 months

Assuming that you prepay the loan by putting in 200,000 after 12 months

The total interest saved would be 1,93,785.

The corresponding loan tenure would also be reduced by 12 months.

First Published: 27 Apr 2022, 07:53 AM IST