A home loan is often the biggest financial commitment of our life. It’s always a good idea to make partial repayments in addition to regular EMIs whenever possible during the life of the loan to reduce the total interest obligation and get out of debt faster. This becomes all the more beneficial as lenders do not charge prepayment fees for variable rate home loans.
Let’s understand the impact of partial 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% per annum Assuming the same interest rate throughout the life of the loan If you do not make any partial prepayment, you will end up paying Rs 2.4 crore in interest and principal at the end of your 30 year term. Now suppose you have made a partial prepayment of Rs 2 lakh at the end of the third year. This will result in the total amount of your refund going down to Rs 2.29 crore. This means that you will be able to save around Rs 11 lakh by paying only Rs 2 lakh in prepayments in addition to reducing the term of your loan.
Partially repay your mortgage
Prepaying a home loan early is one of the best uses for any extra cash or windfall benefits like bonuses, inheritance, financial gifts, etc., that may come your way. Thus, the availability of these funds could be taken into account when partially repaying your mortgage. In fact, since variable rate home loans could go up due to interest rate revisions or a substantial drop in the borrower’s credit rating at any time during the life of the loan, it It may be wise to make as many partial payments as possible when mortgage interest rates are low and your credit score is high.
You may also want to consider partially repaying your mortgage when its interest rate is higher than the return you could get on that amount if it was invested in instruments that meet your risk appetite and liquidity needs.
Additionally, in the early years of the loan, more of your EMI goes to interest interest while only a small portion is adjusted from principal. But at a later stage of your loan, much of the EMI is adjusted to reduce the principal overdue. So, you may also want to make substantial prepayments in the first few years of your mortgage, not only to save on interest expense, but also to reduce your tenure and get out of debt sooner.
Banks and housing finance companies (HFCs) do not charge any prepayment penalties on variable rate home loans. There will be a small cost towards simple interest, which can also be minimized by making the prepayment at the beginning of the month. But lenders can charge a prepayment penalty of about 2% of the amount prepaid in fixed rate home loans.
How much to prepay
Some lenders also restrict the partial prepayment of home loans if the prepayment amount is below the predefined threshold. Most banks charge more than the current IME to make a partial prepayment. However, some banks and financial institutions require at least three times the EMI amount to make a partial prepayment. Thus, before considering making a partial prepayment of a mortgage, make sure you have perfect clarity on the applicable terms and conditions.
Don’t break the bank
While it is ideal to prepay a home loan to get off debt, it shouldn’t hurt your other financial goals such as your emergency fund, your children’s education fund, your goals. retirement, etc. So always keep in mind that your efforts to organize the funds required for partial mortgage repayments should not leave you vulnerable to the vagaries of life or disrupt other important financial goals.
The author is CEO, BankBazaar.com