Prepayment of Home Loan
Prepayment is a payment made towards your home loan before the due date. That is when one pays an excess amount towards his loan to repay his loan earlier, is called pre-payment of the loan.
It not that simple in the financial world and it takes twirl when you dig deep into it. Let’s investigate the norms about pre-payment set by RBI in India and then let’s look if pre-payments helping us or not?
Norms About Pre-Payment in India
Prepayment is not that simple as it calls upon pre-payment charges along with it and you need to pay the simple interest on your remaining loan amount for that month above your pre-payment amount.
Hence it is wise to see whether it’s beneficial to make a pre-payment or invest that amount elsewhere to have a better yield.
It is said that people who follow a strict financial discipline and could yield higher returns in this dynamic market for them only, investing their pre-payment amount elsewhere is beneficial.
For a common person, it is always good to pay the prepayment towards his home loan and try to be debt free as soon as possible.
There are two kinds of options when you intend to prepay your loan, that is you could reduce your EMI while keeping your tenure the same or you could reduce your tenure while keeping the EMI the same.
Whichever way you wish to lessen your loan burden, it will help. One can very easily use loan pre-payment calculators to help them decide on their savings.
You need to enter your loan amount, tenure in months, rate of interest, the amount of your pre-payments and check your results in terms of EMI saved and/or tenure saved.
RBI and NHB in the past few years have come out with pre-payment guidelines and have struck off the prepayment charges in many cases. You do not need to pay pre-payment fee in below cases –
- In case you are an individual and have taken a home loan at a floating rate of interest.
- In case your home loan is provided by a Housing Finance Company and you are doing pre-payment through one of your own sources.
- In case your home loan is based on a dual rate that is fixed for some time and floating afterward and you have passed the fixed rate duration while doing your pre-payments.
However, in below cases, one need to make the prepayment charges –
- If you are not an individual and have taken the home loan in the name of a corporate body.
- In case your home loan is taken at fixed rates from the bank.
- In case you have a fixed rate home loan from
Housing Finance Company s and making a prepayment by borrowing from another bank or
Housing Finance Company.
Prepayment charges are levied to safeguard the interest of banks and to stop a borrower from getting the loan refinanced through other sources.
In case you decide to pre-pay before the loan tenure, the banks often lose their interest earnings and hence they charge hefty amounts to borrower from stop doing it. However, RBI has set these new guidelines for pre-payment to help borrowers to ease out their loan burden without much foreclosure charges levied on them.
Is Loan Pre-payment good for you?
Let’s look at how loan prepayment impacts our loan. Say you have a loan of 30 lakhs for 30 years and you are paying X amount in EMI.
Now most part of this EMI initially is being paid towards the interest amount of your loan and a very little is being paid towards the reduction of the principal of your loan amount.
The interest is then being calculated every month on the remaining principal amount and that interest is deducted from your EMI before reducing your principal amount from the EMI you have paid.
Hence it is wise to say, that while you are paying only the interest amount towards your loan without reducing your principal amount, you would end up paying your loan EMI till eternity. Hence the mantra to be debt free is to reduce your principal amount.
When you may a prepayment in advance, this whole amount of extra prepayment that month is accounted towards your principal amount and your overall loan amount reduces.
Hence now if you were having a loan of 30 lakhs and in the first month of your loan, you make a pre-payment of 2 lakhs, then your loan principal will reduce to 28 lakhs and now your loan interest would be calculated towards remaining 28 lakhs.
Hence, this also empowers your EMIs as now more part of your EMI is being paid towards the principal amount as the interest have been reduced by reducing the principal amount. This will now have a revolving impact on your overall loan.
However, many banks ask you to pay your prepayment in multiples of your EMI. So, if you can’t accumulate a good amount at one single instance, then its almost impossible for you to make a loan pre-payment.
However, you can start with a monthly recurring deposit of your extra amount and continue with it until you have an extra EMI amount to be paid as prepayment.
Another way of loan prepayment is by increasing your EMI amount. Just by increasing your monthly installment by INR 500/-, you could save as much as 2.6 lakhs in the overall loan amount and if the loan tenure was 20 years, it will now get paid only in 19 years. This is the true power of loan prepayment.
People often seek the benefits of taking a home loan in terms of tax benefits however by acquiring your own property, you cease to get benefits under HRA deductions.
This is a huge component of your salary. Hence its always wise to take help of a good financial advisor to help you with your home loan options and to calculate your buy and rent decision.
A home loan is a big debt that you need to live for the next 20 to 30 years of your life. It’s a big burden on your shoulders for a very long tenure which people often fail to understand at the beginning of it.
It not only allows you to buy something you cannot afford right now but also brings an interest burden with it.