Should you Prepay your Home Loan?

By: Aditya Jaiswal

Most home loan borrowers opted for floating rate loans in the past five years. Unfortunately, banks increased the rate on these loans three to four times in the one and a half years. Now, the borrowers are feeling the heat of increased rate of interest.

Those who thought themselves to have sailed safely by buying floating rate loan at 7% in 2003 are now highly tensed. Most banks are charging around 11.50% interest rate.

Let's take a case supposing home loan amount to be Rs 10 lakh and the tenure as 20 years. With the increased rates, the EMI changes from Rs 7,753 to Rs 10,000 or if one wants to keep the EMI amount same, the tenure would increase by more than 10 years.

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It is always adviseable to pre-pay any loan, including the best home loan, if you have extra cash available with you. Most people think that the principal amount outstanding has not reduced even after paying EMI for three to four years.

Considering the above example again, if the borrower prepays at the end of fourth year, the outstanding principal is still around Rs 9 lakh. The borrower is repaying a higher proportion of interest in the initial EMIs. The interest can hover anywhere around 80% in the beginning.

Interest component falls down and principal component goes up as a proportion of the EMI with the loan tenure. For that reason, many of home loan borrowers assume not to prepay an apt way, say, after half way through the loan tenure, because the interest falls.

The interest outgo as a percentage on outstanding principal will remain same every time. As home loan rate is evaluated using reducing balance method, the interest rate is always evaluated on the remaining outstanding principal.

Now, the interest which requires to be distributed accordingly in the remaining tenure would also be low, resulting in lower interest amount component. However, there would come no change in the rate of interest which will remain same at both the periods.

Your home loan tenure should not be a driving factor for you to narrow down on the option of prepaying the loan. It should largely depend on current interest rate and the amount of spare cash with you.

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