Home Loan: Why part-prepayments are a good idea

Try to make as much part-prepayments as possible when the applicable home loan interest rates are low and your credit score is high

A home loan is often the biggest financial commitment of our lifetimes. It is always a good idea to make part-prepayments in addition to regular EMIs whenever feasible during the loan tenure to cut down the total interest obligation and become debt-free faster. This becomes all the more beneficial as lenders do not levy prepayment charges for floating rate home loans.

Let us understand the impact of part-prepayments with the help of an example. Suppose you have an existing home loan of Rs 1 crore with a repayment period of 30 years, and the applicable interest rate is 7% p.a. Assuming the same rate of interest throughout the loan tenure, if you don’t make any part prepayments, you’ll end up paying Rs 2.4 crore in interest and principal at the end of your tenure of 30 years. Now, let’s assume you made a part prepayment of Rs 2 lakh at the end of the third year. This will result in your total repayment amount coming down to Rs 2.29 crore. It means you will be able to save approximately Rs 11 lakh by paying only Rs 2 lakh in prepayments in addition to reducing your loan tenure.

Part-prepay your home loan
Part-prepaying a home loan is one of the best uses of any additional liquidity or windfalls like bonuses, inheritance, financial gifts, etc., that might come your way. So, the availability of such funds could be a consideration while part-prepaying your home loan. In fact, since floating rate home loans could see a hike due to interest rate revisions or substantial drop in the borrower’s credit score any time during the loan tenure, it might be a good idea to make as much part-prepayments as possible when the applicable home loan interest rates are low and your credit score is high.

You can also consider part-prepaying your home loan when its interest rate is higher than the return you may earn on that amount if invested in instruments that are in line with your risk appetite and liquidity requirements.

Furthermore, during the initial years of the loan, a greater portion of your EMI goes towards servicing the interest whereas only a little part is adjusted from the principal. But at a later stage in your loan, a major portion of the EMI is adjusted to reduce the outstanding principal. So, you might also want to make substantial part-prepayments during the initial years of your home loan not just to save on the interest outgo but also to cut down your tenure and become debt-free sooner.

Costs of prepayment
Banks and housing finance companies (HFCs) don’t charge any prepayment penalty on floating rate home loans. There will be a small cost towards simple interest, which also can be minimised by making the prepayment early in the month. But lenders may levy a prepayment penalty of around 2% of the amount prepaid in fixed rate home loans.

How much to prepay
Some lenders also restrict part-prepayment of home loans if the prepayment amount is below the predefined threshold. Most banks require an amount more than the current EMI to make a part prepayment. However, some banks and financial institutions require at least three times the EMI amount to make a part prepayment. So, before you plan to make a part prepayment of a home loan, ensure you have complete clarity about the applicable terms and conditions.

Don’t break the bank
While repaying a home loan through prepayments to become debt-free is ideal, doing so should not undermine your other financial goals like your emergency fund, children’s education fund, retirement goals, etc. So, always keep in mind that your efforts to arrange the required funds for home loan part-prepayments shouldn’t leave you vulnerable to life’s vagaries or disturb other important financial goals.