Prepayment of Home Loan to Reduce EMI

Who does not want to buy a big home, but the limitation is high cost of property. Higher is the cost, more will be the home loan EMI (Equated Monthly Installment’s). The problem with EMI is, it’s a recurring expense. No matter what may come, the EMI will be debited from ones account on a fixed date of every month. Its like a BIG-AUTOMATIC-EXPENSE.

Psychologically, the effect of EMI on the payee is not positive. Its intensity becomes even more magnified when EMI is very high. Is there any way one can reduce EMI of home loan? Yes, by making prepayments EMI can be lowered. Prepayment allows the borrower to pay excess amount, in addition to EMI, and reduce the outstanding principal.

Reducing the outstanding principal directly reflects in the interest payment. High loan balance (principal) will incur higher interest. Low loan balance will incur lower interest. By making prepayments one can reduce the loan balance and save lots of money in interest payment.

Person who is making a prepayment has two alternatives, one is to reduce tenure and other is to reduce EMI. Both ways one can save money. But which is better? Generally, financial gurus will advise people to opt for tenure reduction. Even banks as a default offers tenure reduction. Hence as a result, majority of prepayments made in India are for tenure reduction only. But in this article we are going to discuss the opposite of this trend. We will see how prepayment of home loan to ‘reduce EMI’ can be made a better alternative to ‘tenure reduction’.

EMI Reduction Prepayment

Who would like to reduce EMI? People who have purchased expensive property generally pays high EMI’s. Generally speaking, if more than 60% of ones monthly salary (take home after all deductions) is spent on EMI, it can be classified as expensive. It is important for people to take necessary action to bring EMI back to normal levels. Prepayment is the available alternative for the borrower to reduce EMI. It is important to note that for people who are paying very high EMI’s, for them the number one priority is EMI reduction. Reduction of tenure by prepayment may save more money, but it will not serve the purpose.

If planned correctly, EMI reduction option may prove to be a better alternative than tenure reduction. But before, lets see few exemplary facts about EMI reduction and tenure reduction.

Why prepayment is different when done for EMI Reduction and when done for Tenure Reduction?

When one prepays home loan, loan outstanding is directly reduced. Lower level of loan will charge less interest. This is clear, but why for the same prepayment value, tenure reduction shows higher savings and EMI reduction shows lower savings? This happens due to lowering of EMI. The higher the EMI the faster the loan outstanding decreases. When loan tenure is longer, calculated EMI is lower. When loan tenure is shorter, calculated EMI is higher. Higher EMI means one pays more principal. Lower EMI means one pays less principal. Lets try to understand this with a small example. Two friends Jack and John has taken Rs 50Lakh loan @ 10% interest. But Jack’s loan tenure is 15 years and John’s loan tenure is 20 years. For Jack, the EMI is 48,251 per month. For John the EMI is 53,730 per month. Lets compare how much interest is paid by Jack and John in the first month.
HighEMI More Principal Paid

The table clarifies this very well that why paying higher EMI is advisable. In the first month, both Jack and John is levied the same interest charges (Rs 41,667). But because John is paying higher EMI, the principal adjusted for him, in the first month itself, is higher. As principal amount is reducing faster for John, he will pay lesser interest. Banks in no way will compromise on their interest earning. Lower EMI gets adjusted by paying lesser principal component.

How much savings can be achieved by prepayment (EMI Reduction vs Tenure Reduction)?

For the sake of comparison and clarity lets see a tabulated information. This tables compares savings in ‘EMI Reduction’ & ‘tenure reduction’ for the same prepayment amount. If one makes a prepayment of Rs 60,000 / year (for the total tenure of loan), total savings will be Rs 6,95,431 (in case of EMI Reduction) & Rs 16,81,623 (in case of Tenure Reduction). Similarly, if one makes a prepayment of Rs 180,000 / year (for the total tenure of loan), the savings will be Rs 20,62,574 (in case of EMI Reduction) & Rs 34,21,134 (in case of Tenure Reduction). It is very evident that prepayment for tenure reduction can save more money for the borrower. But there is a way to make EMI reduction equally profitable for the borrower. In fact, I have realized that prepayment (for EMI reduction) can be used as a tool for more controlled & assured wealth creation. Later in this article we will see how this can be achieved.

Prepayment / Year EMI (64Lakhs, @9.55%, 20 Years) EMI Reduction Tenure Reduction Savings Difference
Total Saving Reduced Tenure Total Saving Reduced Tenure
0 59,866 0 20Y 0 0 0
60,000 59,866 6,95,431 20Y 16,81,623 16Y,4M 9,86,192
72,000 59,866 8,34,423 20Y 19,24,059 15Y,10M 10,89,636
84,000 59,866 9,73,415 20Y 21,46,262 15Y,4M 11,72,847
96,000 59,866 11,12,406 20Y 23,49,584 14Y,11M 12,37,177
1,08,000 59,866 12,51,398 20Y 25,38,186 14Y,5M 12,86,788
1,20,000 59,866 13,90,390 20Y 27,10,874 14Y, 2M 13,20,484
1,32,000 59,866 15,29,381 20Y 28,73,902 13Y,11M 13,44,520
1,44,000 59,866 16,68,373 20Y 30,24,299 13Y,3M 13,55,926
1,56,000 59,866 17,93,122 19Y 31,63,880 13Y, 0M 13,70,758
1,68,000 59,866 19,27,848 19Y 32,97,417 12Y,8M 13,69,568
1,80,000 59,866 20,62,574 19Y 34,21,134 12Y,3M 13,58,560
1,92,000 59,866 21,97,300 19Y 35,35,927 12Y 13,38,627
2,04,000 59,866 23,20,728 18Y 36,47,351 11Y,10M 13,26,623
2,16,000 59,866 24,48,752 18Y 37,52,221 11Y,6M 13,03,469
2,28,000 59,866 25,76,775 18Y 38,49,901 11Y,3M 12,73,126
2,40,000 59,866 26,95,142 17Y 39,41,250 11Y 12,46,108

How much EMI can be reduced by Prepayment of home loan?

Prepayment of loan directly lowers the principal amount. Keeping the tenure unaltered, lower principal amount directly lowers the EMI (considering the same interest rate). In order to understand how much EMI can be reduced by prepayment, lets see a table. If one makes prepayment of Rs 60,000/year, after 2nd year, EMI will reduce from Rs 59,866 to Rs 58,708. If one makes prepayment of Rs 96,000/year, after 4th year EMI will reduce from Rs 59,866 to Rs 56,068. If one makes prepayment of Rs 156,000/year, after 10th year EMI will reduce from Rs 59,866 to Rs 40,160. This table has been prepared with an assumption that prepayments have started from the first 12th month itself.

Ask a person who has been paying EMI regularly for last few years. Even small reduction of Rs 500 per month can make them super happy. For a person who is paying very high EMI (compared to income), even minor reduction in EMI may provide them respite.

Prepayment / Year EMI (64Lakhs, @9.55%, 20 Years) EMI (After Prepayment) % Reduction of EMI in 10 Years
2Yr 4Yr 6Yr 8Yr 10Yr
0 59,866 59,866 59,866 59,866 59,866 59,866 0.00%
60,000 59,866 58,708 57,492 56,206 54,821 53,297 10.97%
72,000 59,866 58,477 57,018 55,474 53,812 51,983 13.17%
84,000 59,866 58,245 56,543 54,742 52,804 50,669 15.36%
96,000 59,866 58,014 56,068 54,010 51,795 49,356 17.56%
1,08,000 59,866 57,782 55,594 53,278 50,786 48,042 19.75%
1,20,000 59,866 57,551 55,119 52,546 49,777 46,728 21.95%
1,32,000 59,866 57,319 54,644 51,814 48,768 45,415 24.14%
1,44,000 59,866 57,088 54,170 51,082 47,759 44,101 26.33%
1,56,000 59,866 56,856 53,695 50,350 46,751 42,787 28.53%
1,68,000 59,866 56,625 53,221 49,618 45,742 41,473 30.72%
1,80,000 59,866 56,393 52,746 48,886 44,733 40,160 32.92%
1,92,000 59,866 56,162 52,271 48,154 43,724 38,846 35.11%
2,04,000 59,866 55,930 51,797 47,422 42,715 37,532 37.31%
2,16,000 59,866 55,699 51,322 46,690 41,706 36,218 39.50%
2,28,000 59,866 55,467 50,847 45,958 40,697 34,905 41.70%
2,40,000 59,866 55,236 50,373 45,226 39,689 33,591 43.89%

How to make EMI reduction even more profitable?

When one makes a prepayment and reduces the EMI, they are actually reducing their expense. Reduction of expense means the person has extra money in hand (savings). If one can intelligently invests this money, these saved expenses can generate even more money. Lets take an example. Suppose one made two prepayments of Rs 60,000 each in year 1 and year 2. At the end of second year, due to prepayment, EMI gets reduced from Rs 59,866 to Rs 58,708 per month (EMI reduced by Rs 1,158/month). Now instead of spending this savings elsewhere, if one starts a SIP of this value, it will make the savings grow further. SIP of Rs 1,158/month @ 15% returns will amass a wealth of Rs 9,76,784 in 16 years 4 months).

Lump Sum Prepayment for 2 Consecutive Year EMI (64Lakhs, @9.55%, 20 Years) EMI (After Prepayment) Savings Per Month SIP Tenure (Equivalent to tenure reduction due to prepayment) Investment Return (Time Horizon of 20Y) Wealth Created in 20Years due to SIP Savings Difference
Year 1 Year 2 2nd Yr
0 0 59,866 59,866 0 20 Years 15% 0 0
60,000 60,000 59,866 58,708 1,158 16Y,4M 15% 9,76,784 9,86,192
72,000 72,000 59,866 58,477 1,389 15Y,10M 15% 10,79,401 10,89,636
84,000 84,000 59,866 58,245 1,621 15Y,4M 15% 11,59,781 11,72,847
96,000 96,000 59,866 58,014 1,852 14Y,11M 15% 12,36,223 12,37,177
1,08,000 1,08,000 59,866 57,782 2,084 14Y,5M 15% 12,79,045 12,86,788
1,20,000 1,20,000 59,866 57,551 2,315 14Y, 2M 15% 13,61,984 13,20,484
1,32,000 1,32,000 59,866 57,319 2,547 13Y,11M 15% 14,36,113 13,44,520
1,44,000 1,44,000 59,866 57,088 2,778 13Y,3M 15% 13,96,894 13,55,926
1,56,000 1,56,000 59,866 56,856 3,010 13Y, 0M 15% 14,49,266 13,70,758
1,68,000 1,68,000 59,866 56,625 3,241 12Y,8M 15% 14,72,117 13,69,568
1,80,000 1,80,000 59,866 56,393 3,473 12Y,3M 15% 14,65,553 13,58,560
1,92,000 1,92,000 59,866 56,162 3,704 12Y 15% 14,94,877 13,38,627
2,04,000 2,04,000 59,866 55,930 3,936 11Y,10M 15% 15,41,705 13,26,623
2,16,000 2,16,000 59,866 55,699 4,167 11Y,6M 15% 15,36,703 13,03,469
2,28,000 2,28,000 59,866 55,467 4,399 11Y,3M 15% 15,49,880 12,73,126
2,40,000 2,40,000 59,866 55,236 4,630 11Y 15% 15,57,874 12,46,108

Conclusion

It is essential to make prepayments to save on interest component of loan. But apart from the interest savings, prepayment can also serve another purpose. Prepayment can help to improve present cash-flow of a person by reducing monthly EMI. When prepayment is made for EMI reduction, the benefit gets split into three: (1) reduced EMI, (2) smaller interest savings & (3) marginal tenure reduction. In case of prepayment for tenure reduction the benefit is only two (1) large interest savings & (2) large tenure reduction. If one invests the differential amount (reduced EMI) properly, benefits of prepayment for EMI reduction can further be enhanced.



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About the Author

Mani
I am a Blogger with a passion for investment education. I started blogging in 2007-08. Blogging didn’t happened to me as a coincidence, it was a conscious decision. The idea with which I started blogging still stands true. In my starting days my finances remained tight. I was reading heavily about how to manage finance. One day I got hold of a book which my father gifted me in 2003. It was stacked below my graduation books. It was a small-thin book with its cover named "Rich Dad Poor Dad".....more

6 Comments on "Prepayment of Home Loan to Reduce EMI"

  1. Dear Sir ,
    want to know the method of reducing tenure of home loan.
    which are better option whether to make repayment of home loan at the end of financial year or make payment on monthaly basis
    want to know the benefit of both the option

  2. Hi, I am having current home loan of Rs 26 lac. and I am planning to do prepayment of rs 1.5 lac.but I have invested in Mutual fund as well and my investment for mutual funds has grown by 50% .so I am confused should I invest this money or do prepayment for home loan. and in case if I do prepayment .what should be my strategy . reduce tenure or emi. My current tenure is 12 years and interest rate is 9.4%

    Thanks

  3. Where is home loan prepayment calculator?

  4. Very useful post indeed.

    I glad that i landed in the proper place to understand prepayment of home loan.

    Thanks for sharing 🙂 Happy new year 2016

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