What is the best time to Prepay your Home loan?

As soon as they take a home loan, most people start thinking about how to prepay home loan quickly and close it as soon as possible. For home loan borrowers, doing home loan prepayment can be financially beneficial as it helps reduce the Interest burden and consequently, also reduce the overall cost of the property.

In this post, we look at the best time to prepay home loan or/and the best time to part-prepay your home loan in India (2021)

I am sure you know how home loan EMI works. So let’s move ahead and first choose a scenario to discuss this further: Suppose you want to purchase a house that costs Rs 62.5 lakh. For this you need to make 20% downpayment, i.e. Rs 12.5 lakh is to be brought in by you as a downpayment. The remaining amount is to be funded via home loan. So you have taken a home loan of Rs 50 lakh at 8% interest rate for a period of 25 years. For this, the monthly EMI is Rs 38,591. More importantly, for this Rs 50 lakh loan, you end up paying a total interest of Rs 65.8 lac during the full 25-year loan tenure.

Now if you look at the regular home loan amortization table (below), then this is how the repayment schedule of your Rs 50 lakh home loan looks like:

50 lakh home loan amortization

Now spend some time in the table above and make the following observations:

  • After 5-years (20% of total tenure), only 7.7% of the loan principal is paid off
  • After 10-years (40% of total tenure), only 19.2% of the loan principal is paid off
  • After 15-years (60% of total tenure), only 36.4% of the loan principal is paid off
  • After 20-years (80% of total tenure), only 61.9% of the loan principal is paid off
  • After 25-years (100% of total tenure), full 100% of the loan principal is paid off

You will notice that even after the first 5 years of regular payment, which is 20% of the loan tenure, only 7.7% of the loan is paid off. And similarly for other tenures like 10-years, 15-year etc. So why is it that the outstanding principal amount reduce slowly during the initial years?

Let me try and explain it in simple terms.

Monthly EMI is made up of 2 parts. First is the interest component on the outstanding amount and second is the principal component.

Now using the home loan EMI calculator, we know that the EMI is Rs 38,591 for a Rs 50 lakh home loan at 8% for 25 years.

Now let’s break this EMI into 2 components and see what part goes towards principal repayment and what part goes towards interest payment?

Month 1: 

  • Outstanding Loan Principal at the beginning of month = Rs 50 lakh
  • Interest to be paid for month = 50 lakh * 8%/12 = Rs 33,333
  • Principal payment for month = EMI – Interest Payment = 38,591 – 33,333 = Rs 5258
  • Outstanding Loan Principal at the end of month = Rs 49,94,742

Month 2: 

  • Outstanding Loan Principal at the beginning of month = Rs 49,94,742
  • Interest to be paid for month = Rs 49,94,742 * 8%/12 = Rs 33,298
  • Principal payment for month = EMI – Interest Payment = 38,591 – 33,298 = Rs 5292
  • Outstanding Loan Principal at the end of month = Rs 49,89,450

Month 3: 

  • Outstanding Loan Principal at the beginning of month = Rs 49,89,450
  • Interest to be paid for month = Rs 49,89,450 * 8%/12 = Rs 33,263
  • Principal payment for month = EMI – Interest Payment = 38,591 – 33,268 = Rs 5328
  • Outstanding Loan Principal at the end of month = Rs 49,84,122

And this continues month after month for years (up to loan tenure)

Here are a few things worth highlighting:

  • A major chunk of your EMI goes towards interest servicing in the initial part of the loan
  • Every month, a slightly large amount (than previous month) goes towards principal repayment.
  • So every month, the interest payment for the month goes down while principal repayment goes up.

Have a look at the annual loan amortization table above again. You will realize that the interest component paid is higher during the initial years. During the latter years, the principal component is higher. With each passing month’s EMI, the interest paid decreases and the principal repaid increases. Many people know this. But many don’t. Do spend some time studying the earlier table.

And let me show you the monthly EMI table for 1st one year:

Home loan amortization schedule 1

And here is the table for the 11th year.

Home loan amortization schedule 2

Notice the difference. The monthly EMI is same. But the amount that is going towards interest payment gets lower and lower after each month. Consequently, the amount of principal being repaid every month keeps on increasing every month.

So now you know how the EMI composition changes every month even though the EMI amount for the borrower remains the same.

You can see that the bulk of EMI payments during the initial years goes towards interest payment. And it is for this reason of front-loading of interest payment, that if you want to make part prepayment of your home loan, then it’s better to do so in the initial years itself. The home loan principal gets paid off very slowly during the initial years. And hence, initial years are the best time to prepay the home loan.

That is how do prepayment of home loan works.

Now let’s move ahead

Suppose you want to make a one-time prepayment of Rs 5 lakh in your Rs 50 lakh home loan.

Now let’s see how 2 things are impacted depending on when you make the prepayment. First, how the total interest paid during the 25-year tenure is impacted; and Second, how many EMIs you save and how early is the loan closed.

  • No Prepayment: Total interest paid Rs 65.7 lakh. Loan Tenure: 25-years (300 EMIs)
  • Prepayment of Rs 5 lakh in 1st year: Total interest paid Rs 42.7 lakh. New loan tenure is 19 years (i.e. 228 EMIs), and about 72 EMIs are saved.
  • Prepayment of Rs 5 lakh in 2nd year: Total interest paid Rs 44.4 lakh. New loan tenure is 19-20 years (i.e. 232 EMIs) and about 68 EMIs are saved.
  • Prepayment of Rs 5 lakh in 3rd year: Total interest paid Rs 46.1 lakh. New loan tenure is 19-20 years (i.e. 237 EMIs) and about 63 EMIs are saved.
  • Prepayment of Rs 5 lakh in 4th year: Total interest paid Rs 47.6 lakh. New loan tenure is 20 years (i.e. 241 EMIs) and about 59 EMIs are saved.
  • Prepayment of Rs 5 lakh in 5th year: Total interest paid Rs 49.1 lakh. New loan tenure is 20-21 years (i.e. 245 EMIs) and about 55 EMIs are saved.
  • Prepayment of Rs 5 lakh in 6th year: Total interest paid Rs 50.5 lakh. New loan tenure is 20-21 years (i.e. 249 EMIs) and about 51 EMIs are saved.
  • Prepayment of Rs 5 lakh in 7th year: Total interest paid Rs 51.8 lakh. New loan tenure is 21 years (i.e. 251 EMIs) and about 49 EMIs are saved.
  • Prepayment of Rs 5 lakh in 8th year: Total interest paid Rs 53.1 lakh. New loan tenure is 21-22 years (i.e. 254 EMIs) and about 46 EMIs are saved.
  • Prepayment of Rs 5 lakh in 9th year: Total interest paid Rs 54.3 lakh. New loan tenure is 21-22 years (i.e. 257 EMIs) and about 43 EMIs are saved.
  • Prepayment of Rs 5 lakh in 10th year: Total interest paid Rs 55.4 lakh. New loan tenure is 21-22 years (i.e. 260 EMIs) and about 40 EMIs are saved.

So prepaying Rs 5 lakh in the first year itself will result in savings of Rs 23 lakh (i.e. Rs 65.7 lakh – Rs 42.7 lakh) over the course of full tenure. But prepaying the same amount instead in the 10th year will only result in savings of about Rs 10 lakh (i.e. Rs 65.7 lakh – Rs 55.4 lakh).

Note – We have kept interest rate constant at 8% but in reality, it might and does fluctuate. We have also not considered the tax benefits on home loan repayment for simplicity.

To state the obvious, the earlier you make the prepayment(s), better it is for you in terms of its impact on reducing the total interest paid during the tenure. And that is because a major part during the first few years is only about paying interest. That is, the interest is front-loaded.

By the way, do not think that prepayment will only benefit if you do it in initial years. It is just that it provides maximum benefit when you do it early in tenure. The benefit goes on reducing as you delay the prepayment to later years.

Now I am sure you will also this question

Should I reduce EMI or reduce Home Loan Tenure?

Once you make a prepayment, the outstanding loan amount reduces. So you can either shorten the loan tenure and keep the EMI constant OR reduce the EMI and keep the loan tenure constant. Lenders generally keep the EMI constant and reduce the home loan tenure. Some lenders might go for the opposite and reduce the EMI and keep the tenure constant.

So to answer your question of Should I reduce EMI or reduce Home Loan Tenure? I would say that Financially, it is better to reduce Home Loan tenure instead of loan EMI.

Another question that many people have is…

Should I invest or make Home Loan Prepayment?

Mathematically speaking, if you are confident of generating returns at a rate higher than your loan rate, then you are better of investing rather than prepaying. But most people can’t be sure of that. And having a large loan hanging over the head is another mental issue. So depending on what suits whom, a decision should be taken whether to prepay or to invest elsewhere.

Further readings:

Before I end this discussion, a couple of more points:

  • Always keep some money for unplanned expense in emergency fund. Do not try to use the emergency fund to prepay your loan. If you have access to loan overdraft facility which allow you to park cash temporarily to reduce the effective outstanding loan, then you can use it to park your emergency fund and lower your loan interest together
  • If you have other high-interest loans like personal loans or credit card dues, then instead of prepaying the home loan, clear off those high-interest dues first.

So I hope you got the answer to when is a good time to part-prepay your home loan 2021?

Prepaying to reduce your outstanding home loan is a financially beneficial move for home loan borrowers. It helps to reduce Interest burden thus the overall cost of property. And the best time to prepay home loan is during the initial part of the loan when the principal amount is large.

1 comment

  1. Since people usually take a loan for at least 15 years can you give us a comparison of returns generated by the nifty/sensex for 2-3 recent 15year periods so it would be easier for people to decide if investing in an index fund is better or prepaying the loan is a better option

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