Home loans are a long-term financial liability, normally running for decades. But many home buyers desire to reduce their loan term and interest burden. One of the best ways to do that is prepayment. But how does the prepayment of a home loan work? Let’s uncover the word and its advantages in detail.
What is Prepayment of Home Loan?
Prepayment for a home loan is paying an additional amount towards the principal amount before the repayment tenure completion. This reduces the total interest paid and the tenure of the loan. Prepayment can be made in two forms:
- Partial Prepayment: Paying an additional amount above the normal EMI.
- Full Prepayment: Clearing the entire outstanding amount of the loan before the tenure.
Prepayment of home loans is allowed by most financial institutions and banks, although some of them levy a prepayment penalty. One should check the terms and conditions before making a prepayment.
How Home Loan Prepayment Works
Prepayment of a home loan is a method of repayment of an additional amount towards the principal. Since interest is payable on the outstanding balance, reducing the principal results in reduced interest payment.
To find out the impact of prepayment, a borrower can use a home loan calculator. The calculator helps borrowers understand how an extra payment can cut down the tenure of the loan and the total interest paid.
For example, if a borrower has an INR 50 lakhs home loan at an interest rate of 8% for 20 years and wants to prepay INR 5 lakhs, then the interest outgo can be minimized considerably and the loan can be prepaid ahead of the original period.
Benefits of Home Loan Prepayment
Reduction in Cost of Interest: Since interest is being charged on the outstanding of the loan, prepayment of a portion of the principal amounts to saving overall interest burden.
- Earlier Repayment of Loan: Prepayment shortens the repayment period, and borrowers become debt-free sooner.
- Improved Credit Record: Regular repayment and ongoing prepayments reflect positively on a borrower’s credit score.
- Increased Financial Freedom: Payment of a housing loan much earlier than scheduled liberates the amount for other expenses.
- Tax Relief Maintained: While prepayment reduces the loan tenure, the borrowers still enjoy tax relief on interest repayment under Section 24(b) and principal repayment under Section 80C of the Income Tax Act.
Things to Consider Before Making a Prepayment
While there are several advantages of home loan prepayment, the borrower must keep in mind a few things:
- Prepayment Charge: Some banks also levy a prepayment charge, primarily for fixed-interest loans.
- Opportunity Cost: If the prepayment amount can return higher elsewhere (e.g., investments), it might be better to invest rather than prepay.
- Emergency Fund: Ensure prepayment does not drain financial resources for emergencies.
- Loan Interest Type: Floating-rate loans do not usually come with prepayment charges, so they are better for prepayment.
Using a Prepayment of Home Loan Calculator
A prepayment of home loan calculator helps you make intelligent financial choices. With data such as loan outstanding, interest rate, term, and prepayment, customers can calculate the impact on savings of interest and loan tenure. With this calculator, customers can plan prepayment strategically without impairing their financial condition.
How to Make Home Loan Prepayment?
The procedure of prepaying a home loan is easy and differs marginally from lender to lender. Here’s how one can proceed:
- Check Outstanding Balance: Ask the bank or financial institution for a loan statement.
- Calculate Prepayment Impact: Apply a home loan prepayment calculator to determine how much interest and tenure can be saved.
- Arrange Funds: Ensure prepayment does not impact liquidity for necessary expenses.
- Contact the Lender: Go to the bank or financial institution to prepay. Some lenders also have online prepayment facilities.
- Get a New Loan Statement: After making a prepayment, take a new loan schedule indicating the new EMI or shortened tenure.
Best Strategies for Effective Prepayment
- Pay Lump-Sum Amounts: As far as possible, pay bonuses, incentives, or extra income in advance towards part-prepayment of the loan.
- Increase EMI Amount: A slight increase in the EMI payment makes a huge difference in terms of saving interest charges in the long term.
- Use Windfalls Wisely: Any surplus amount from investments, sale of real estate, or inheritances should be utilized towards prepayment.
- Prepay in the Initial Years: The interest is higher during the early years of the loan period, so prepaying during these years saves the most.
Conclusion
Home loan prepayment is an excellent choice for reducing interest costs and becoming debt-free earlier. However, one should consider financial health, prepayment fees, and opportunity costs before making a decision. Borrowers can manage their finances efficiently with the assistance of a personal loan interest rate calculator or a personal loan EMI calculator.
At MyFinanceCare, we assist borrowers in understanding the nuances of home loan prepayment and offer tools like home loan prepayment guides and home loan prepayment calculators to facilitate easy financial planning. If you want to optimize your loan repayment plan, we are here to assist you in making the right decisions for a secure financial future.
