Should You Make Prepayments In Your Home Loan?

Understanding Home Loans

A home loan is a secured loan taken from a bank or financial institution to purchase a property. Unlike personal loans, which have higher interest rates and shorter tenures, home loans come with lower interest rates and longer repayment periods, making them more manageable for borrowers.

Interest Rates and Loan Tenure

Home loan interest rates in India generally range from 7% to 10% per annum, significantly lower than personal loans, which often exceed 12-15%. Common tenures for home loans include:

• 10 years: Higher EMI, lower total interest paid.
• 20 years: Balanced EMI with moderate total interest.
• 30 years: Lower EMI, but significantly higher total interest paid.

Longer tenures make monthly payments affordable but result in higher overall interest costs.

What is Home Loan Prepayment?

Prepayment refers to paying an additional amount over the regular EMI to reduce the outstanding loan balance. Prepayments can impact your loan in two ways:

1. Reducing Tenure: Your EMI remains the same, but the number of EMIs decreases.
2. Reducing EMI: Your tenure remains the same, but your EMI amount reduces.

How Much and How Often Can You Prepay?

Most banks allow partial prepayments without penalties, especially on floating-rate loans. Some guidelines include:

• No restriction on prepayment amount, but some banks require a minimum amount (e.g., 1 or 2 EMI equivalents).
• You can prepay multiple times a year.
• Ideally, prepay during the initial years when interest forms the largest part of EMI payments.

Should You Prepay Your Home Loan?

So, what is the right approach? Should you prepay your home loan, and if so, how much? The answer depends on several factors, including the remaining tenure, loan amount, interest rate, and your financial knowledge. If your loan tenure exceeds 20 years, prepayment can be a wise choice. Similarly, if your interest rate is above 10%, paying off your loan early can save a significant amount in interest. However, if you have the expertise to invest the surplus funds and generate higher returns than your loan's interest rate, investing might be the better option. Let's explore this further with a case study:

Case Study: Loan Prepayment vs Investment

Consider a ₹50 lakh home loan at 8% interest for 20 years. The EMI is approximately ₹41,822. By the third year, the borrower decides to prepay ₹1 lakh.

Impact of Prepayment:

• Loan tenure reduces by 6-8 months.
• Total interest saved: ₹3-4 lakh over the loan period.

Alternative: Investing Instead of Prepaying

If the borrower invests ₹1 lakh in a mutual fund earning 12% annual returns, in 17 years, the investment could grow to ₹6.5 lakh, far exceeding the ₹3-4 lakh saved via prepayment.

Best Approach: Balance Between Prepayment and Investment

1. If you lack investment knowledge, prepaying is a safe choice. Use our Home Loan EMI Calculator with Prepayments for calculating emi, tenure and interest.
2. If you can invest smartly, you might earn more by investing rather than prepaying. Use our SIP Calculator for calculating mutual fund SIP returns.
3. Start an SIP alongside your loan—even a small ₹5,000 SIP in equity funds can accumulate wealth, potentially covering your total interest cost.

Conclusion

Prepaying your home loan can save interest, but investing wisely may generate better returns. The best approach depends on your financial knowledge and risk appetite. If you can earn higher returns than your loan interest, investing is a smarter choice. Otherwise, regular prepayments, especially in the early years, help reduce the financial burden.