How Prepaying Your Home Loan Can Help You Save on Interest

In on of the blogs, we have outlined how home loan part payment works. Your Home Loan,, barring processing fees, has two components – the principal amount (the loan amount disbursed) and the interest component During the initial years, you pay more towards the interest component. The interest component gets reduced at the end of the loan tenure. To bring down the interest component during the early stages of your loan, you can either make part prepayments (prepayment done in tranches) or prepay the outstanding loan amount in full. Once your make part prepayment, the next month’s EMI will be calculated only on the outstanding amount remaining after your prepayment is applied to the principal amount. 

This significantly reduces the interest amount and helps you clear the outstanding principal faster. But are there any consequences of home loan prepayment?

In this article, we will explore the advantages of prepaying your home loan and if there are any cons of such. Let’s dive in!

Why You May Consider Prepaying Your Home Loan?

1. Reduces Interest Cost 

One of the major home loan prepayment benefits is the significant savings on interest costs. The interest component forms a substantial portion of your monthly EMI, especially for long-term loans. By prepaying your home loan, you can save lakhs of rupees compared to sticking with the predetermined tenure.

Let's consider an example to understand this better. Suppose you have taken a home loan of ₹75 lakhs at an interest rate of 7.5% per annum for 20 years. If you continue with the regular repayment schedule, you will pay ₹1,53,00,000 for the loan. However, if you manage to prepay the loan by year 12, the total cost for the property will be ₹1,20,00,000. That's a substantial saving of almost ₹33 lakhs.

2. Provides Access to Home Equity 

Real estate is a valuable asset that appreciates over time. Despite the potential value of your home increasing, it remains locked until you decide to sell the property. However, if you wish to tap into your home's equity without selling it, prepaying your home loan EMI can make that possible. 

You can access a home equity loan by prepaying your home loan and owning your property outright. These financial products allow you to borrow against the current market value of your home. The borrowed funds can then be used for various purposes, such as purchasing additional real estate, funding business ventures or startups, or investing in other assets that generate higher returns. 

3. More Efficient Use of Resources 

Besides saving on interest costs, prepaying your home loan EMI allows you to allocate your resources better and plan for future goals. When you prepay your loan, you free up cash flow that can be utilised for other important financial needs. 

For example, you can invest the surplus amount in a high-interest Fixed Deposit account. 

4. Enhances Eligibility for Additional Loans 

Prepaying your home loan EMI might boost your eligibility for other loans. A large mortgage can limit your ability to borrow additional funds, as banks may perceive it as a high risk. 

Prepaying your home loan early enhances your eligibility for future loans when needed. This way, you won't have to compromise on the loan amount required for essential needs. 

5. Can Help in Achieving Financial Security 

A home loan is a long-term commitment, and unforeseen circumstances like loss of income, accidents, or global crises can disrupt your financial stability. Falling behind on EMIs could even result in losing your house. 

By prepaying your home loan, you achieve a significant milestone and gain peace of mind knowing that you can handle any financial challenge and protect your family's future.

Are There Any Pitfalls of Home Loan Prepayment?

1. Did you Opt for Floating or Fixed Interest Home loan?

For the unversed, there are two types of interest rates applicable on home loans – fixed interest rate and floating interest rate. If you have opted for fixed rate home loan, banks may levy a prepayment penalty fee, which usually ranges between 1% and 2% of the outstanding loan amount. For floating rate home loans, as per RBI mandate, no such penalty charge is applicable.

2. Consider Home Loan Tax Benefits

One of the primary advantages of home loans is the tax benefits they offer. You can save more on your tax outgo – both on the principal and interest component- if you have an ongoing home loan. If you prepay your home loan, you won’t be eligible for tax benefit. Kindly note – you can avail tax benefits only if you have opted for the old tax regime. 

3. Losing Out on High Returns Investments

If you’re planning to utilise your savings to prepay your home loan, think again. Let’s say you have received company bonus. Do you want to invest it in capital markets and FDs for potential higher returns or use the amount to prepay you loan? Okay, we get it circumstances and goals could be different across individuals. Consult a SEBI-registered investment adviser and take the best possible decision aligned with your goals.