Home loan prepayment: what it saves, and when to invest instead
A home loan is the largest debt most families take. Small extra payments early in its life remove a surprising amount of interest.
Where the EMI goes
Take ₹50 lakh at 8.5% for 20 years. The EMI is ₹43,391 and total interest over the term is about ₹54.1 lakh. In the first year you pay about ₹5.2 lakh in EMIs, of which roughly ₹4.2 lakh is interest and only about ₹1 lakh reduces the loan. Interest is charged on the outstanding balance, so the early years are the expensive ones.
What one prepayment does
Suppose you prepay ₹5 lakh at the start of that loan and keep the EMI unchanged. The loan finishes in about 188 months instead of 240, more than four years early, and total interest falls from about ₹54.1 lakh to about ₹36.5 lakh. A ₹5 lakh payment saves roughly ₹17.6 lakh. The same payment in year 15 saves a fraction of that, because little interest remains to be avoided.
Reduce tenure or reduce EMI?
After a prepayment the lender can shorten the tenure or lower the EMI. Shortening the tenure saves more interest. Lowering the EMI improves monthly cash flow. If your budget is comfortable, keep the EMI and take the shorter tenure.
Prepay or invest?
Prepaying earns a certain return equal to your loan rate. Investing earns an uncertain return that may be higher or lower.
- Prepay first if the loan rate is high, the loan is young, you value being debt-free, or you would otherwise leave the money in a savings account.
- Invest first if you have no emergency fund, no retirement savings, or you are in the old tax regime and the interest deduction lowers your effective loan cost.
- Split it if you are unsure. Many households send part of each bonus to the loan and part to long-term investments.
Do not use money you may need within a year. Once paid in, it is hard to get back.
Practical points
- Lenders cannot charge prepayment penalties on floating-rate home loans to individuals.
- Ask for the revised amortisation schedule after each prepayment and check that the tenure has changed as requested.
- If your rate is well above what new borrowers get, ask your lender to reprice the loan or consider a balance transfer after counting fees.
- An annual habit beats a single large payment: one extra EMI a year takes years off a 20-year loan.