Prepay home loan in small chunks and reduce your liability:

Ever wondered how much interest you end up paying on your home loan throughout the entire tenure. If you never pondered about this figure, it will come as a big shocker for you. Since the interest on home loan is compounded monthly, you will end up paying an amount which is near equivalent to the loan amount or most probably even higher than that. Say, for instance, you have taken a home loan of Rs.50 lakh at 10 per cent interest for a period of 20 years. The cumulative interest that is chargeable on this loan is a huge Rs.65.8 lakh. A home loan is the biggest liability an individual takes on in his lifetime and spends a major part of his working life to repay it.

Banks usually recover huge interest in the initial years of the loan tenure, wherein the interest component is very high, at least 80-85 per cent of the total EMI. Sadly, most people end up repaying a major portion of the loan towards the end of the tenure. 

Additionally, the 1-2 per cent prepayment penalty imposed by the bank in the initial years of the loan act as a deterrent to repay. Even restrictive practices like foreclosure charges discourage borrowers to switch to another bank with a cheaper loan offer. It is like a punishment for repaying the bank’s money before time!

Recently, in a major relief to home loan borrowers, the RBI has directed banks to remove the prepayment penalties and foreclosure charges on floating rate home loans with immediate effect. This means that you can prepay as much as you want at any time of the year. This does not imply that you repay only when you have a big lump sum amount on hand. You can even prepay in small chunks every month or every quarter which will reduce your liability to a great extent.

Picture this - Suppose you have a loan of Rs.50 lakh for tenure of 20 years at an interest rate of 10 per cent per annum. The EMI for the loan comes to Rs.48,251. Over and above this, suppose you pay Rs.1000 every month from the first month as part prepayment towards the principal amount, you would save an amount of Rs.4.7 lakh and get to reduce the loan tenure by 1.1years. The detailed table assuming different scenarios is explained below for a loan of Rs.50 lakh for 20 years @ 10 per cent interest:

Principal Prepayment                    Tenure Reduction                     Interest Saved

 (per month - in Rs)                           (in years)                               (in Rs)

         1,000                                            1.1                                       4.7 lakh

         2,000                                            2.3                                       8.8 lakh

         3,000                                            3.1                                       12 lakh

         5,000                                            4.7                                       18 lakh

Thus prepaying the loan amount regularly in small instalments will eventually make a big difference in the total interest paid and the loan tenure. Creating your own loan amortization schedule and setting a deadline to repay your loan will certainly help in this regard. The end result is that the faster you pay off your home loan, the greater savings you will have on hand to grow your investment corpus. And with your biggest liability being paid off, you would already be on the path of financial freedom.