Discover 2 practical ways to prepay your home loan

Prepaying home loans can free you from a big burden.
You can save a lot on interest and the saved money can be used to meet your other financial needs or for investing elsewhere. This savings is indirectly income earned.
The risk of losing ownership due to loan defaults gets mitigated.
Your credit score will increase, thus improving your creditworthiness.

Disadvantages of prepaying loans

If you have a self-occupied property, you can claim up to Rs. 2 lakhs (on interest) as a deduction.
If you have a let-out property, you can claim the actual interest paid.

For both self-occupied and let out property, you can claim up to Rs.1.5 lakh as a deduction (on principal).
These are the tax benefits that you may lose if you opt for home loan prepayment.
By prepaying, you may end up with no funds and it becomes difficult in case of emergencies.

Now we will see the ways in which you can prepay your home loan.

How can you Prepay your home loan?

Home loan prepayment can be done in two ways, either by,

1. Lump-sum prepayment (or)
2. Top-up EMI payment.

Now, we will see how these different methods of prepayment work.

Also read, “Warning: Don’t opt for EMI Moratorium! Discover why?”

1. What is Lumpsum Prepayment?

When you use a lump sum amount for one time prepayment, it is called as Lumpsum Prepayment. It may be the amount received as a bonus, increment, an amount from investment matured, or maybe a sum received as a gift.

Here is a link to the Lumpsum prepayment calculator.

This calculator will help you know the impact of prepayment, i.e. the amount you would be saving on interest and the months by which your tenure has reduced. We will find how this calculator works with the help of an example.

Example: You take a loan for Rs. 20 lacs, for a tenure of 20 years @ 9% interest.

Workings in the calculator: Just enter the below details, in the calculator.

The loan amount,
The loan tenure, and
The rate of interest.

Now if you plan to prepay Rs. 3 lacs in the 24th month.
Just enter them.

The month in which you are going to prepay and
The amount you wish to prepay.

Entering the above details in the lumpsum prepayment calculator you will automatically get

The actual interest that is payable.
The interest to be payable after the lumpsum prepayment.
The total interest saved with lumpsum prepayment and
The no. of months decreased by lumpsum prepayment.

Here, in this case, the actual interest to be payable was Rs. 23,18,685, after the lumpsum prepayment, it becomes Rs. 14,44,997 and the amount you have saved on interest is Rs. 8,73,688 and the loan tenure also decrease by 65 months. This is how lumpsum prepayment works.

Now we will see the workings of Lumpsum EMI from the Sheet 2 of the lumpsum prepayment calculator.

(In relation to the above example) We will see what happens when you prepay Rs.3 lacs as a lump sum in the 24th month. Look to the below table, when you prepay, your interest payable and the outstanding loan amount decreases drastically.

This is how Lumpsum Prepayment works.

You can download the lumpsum prepayment calculator here.

Now we will see what is Top-up EMI.

2. What is Top-up EMI Prepayment?

Increasing your EMI’s on a yearly basis, at a certain percentage is called Top-up EMI Prepayment. Say for example, increasing the EMI amount by 5% every year… It can be done with an annual increment. This is a simple, easy and a very practical way to prepay your house loan.

Here is a link to the Top-up EMI Prepayment calculator.

We will find how this calculator works with the help of an example.

Example: You take a loan for Rs. 20 lacs, for a tenure of 20 years @ 9% interest.

Just enter the below details in the Top-up EMI Prepayment calculator.

The loan amount,
The loan tenure, and
The rate of interest.

Now enter in the Top-up EMI Prepayment calculator,

The month in which you are going to top up the EMI and
The percentage you would like to increase on EMI every year.

Entering the above details you would automatically get

The actual interest that is payable.
The interest to be payable with Top-up EMI.
The total interest saved with Top-up EMI.
And the no. of months decreased by Top-up EMI.

The actual interest to be payable was Rs. 23,18,685 and it becomes Rs. 15,24,372, after topup EMI payment and the amount you have saved on interest is Rs. 7,94,313 and the loan tenure also decrease by 89 months.

This is how Top-up EMI works.

Now we will see the workings from the sheet 2 of the Top-up EMI Prepayment Calculator. (In relation to the above example)

Look at the below table, to find what happens when you increase EMI by 5% from the 20th year. Your interest payable and outstanding loan amount decreases gradually.

This is how Top-up EMI Prepayment of housing loan works.

You can download the Top-up EMI Prepayment calculator here.

In both the prepayments, there is definitely an amount you would be saving on interest and also a reduction in the loan tenure. So, it is definitely beneficial.

Now we will see a few commonly asked questions.

Should You invest or make Home Loan Prepayment?

To know this find the maximum returns you will get per annum with an investment. Also, find how much you will be able to save per annum if you prepay in part or full. Find which is more profitable, the prepayment, or the investment, then choose accordingly.

Example: You have 3 lakhs of idle funds, you can use it for either prepayment or investment, but before that, compare the amount you receive from the investment and amount saved on home loan prepayment. Say you get Rs. 3,15,000 from the investment and you are saving Rs.4,20,000 from the home loan prepayment.

Which would you choose?

You would opt for the home loan prepayment. Likewise, you should check which is beneficial for you and opt for that which is beneficial.

Also read, “A Basic Checklist: 5 Key Aspects to Check in Any Investment Before You Invest”

Should you reduce the home loan’s tenure or the EMI?

Reducing home loan tenure instead of EMI will help reduce the total interest outflow. It is always advisable to increase the EMI amount as and when the salary increases. This will help you prepay your loan faster and would help you save on interest and also reduce your home loan tenure.

If you instead reduce your EMI, you will have to pay a lot more on interest, and the loan tenure also increases. Hence it’s beneficial to reduce your home loan tenure, not your EMI.

Don’t you think reducing your home loan tenure is more beneficial?

Conclusion

From this article, you would have got a better understanding of home loan prepayment. There are a lot of benefits to prepaying your home loans, but it’s also good to know the disadvantages before prepaying your home loan. Make a wise choice, considering all the above factors.