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Home > Home Loan > Learn > How to Calculate the Right Prepayment Amount for Home Loans?

How to Calculate the Right Prepayment Amount for Home Loans?

December 17, 2024
7 min read
Table of Contents

Estimated reading time: 7 minutes

The instinct to eliminate debt as quickly as possible is common, particularly when it comes to loans. However, not all debt should be treated the same. A home loan, for instance, should not necessarily be viewed in the same light as personal loans or credit card debt.

Before rushing to make a home loan prepayment, consider various strategic factors that could influence your financial well-being.

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Prioritize Liquidity Over Prepayment

First and foremost, assess your cash flow needs. Prepaying a home loan might seem like a prudent step, but it can lead to cash shortages if not planned correctly.

Ensure you have enough liquid funds to meet life’s milestones—such as marriage, education, or international travel—and to handle emergencies like medical needs or job loss. Liquidity is key to financial stability; never compromise it for the sake of prepayment.

Evaluate Returns from Investments vs. Home Loan Costs

Compare the interest cost of your home loan with the potential returns from alternative investments. If investment avenues like equity can offer returns that surpass your home loan interest rate, channeling surplus funds into these investments might be more rewarding.

Historical data shows that the BSE Sensex has delivered annualized returns of around 15% over the past 15 years. When contrasted with a typical home loan interest rate of 9%—which can effectively be reduced to 6.3% due to tax benefits—investing in equities could provide superior financial growth over the long term.

Timing of Prepayment Matters

The timing of your prepayment is crucial. The interest component of your Equated Monthly Installment (EMI) is significantly higher during the early stages of the loan tenure.

Therefore, prepaying in the early years will save more on interest compared to prepaying later when the interest component of the EMI diminishes. For loans at their mid-to-late stages, redirecting surplus funds to investments often makes more sense.

Prioritize High-Interest Debt First

Home loans typically have lower interest rates compared to other forms of debt like personal loans or credit card debt. If your goal is to reduce overall debt, prioritize repaying high-interest loans first.

This approach will minimize your interest outgo and improve your overall financial health more effectively than prepaying a lower-cost home loan.

Consider the Loss of Tax Benefits

Home loans come with significant tax incentives. You can claim deductions of up to ₹1.5 lakh per financial year on the principal repayment under Section 80C.

Additionally, the interest paid on home loans is tax-deductible up to ₹2 lakh for self-occupied properties, with no cap for let-out properties. By prepaying your loan, you lose out on these valuable tax benefits.

Carefully consider whether the savings from prepayment outweigh the tax benefits lost.

Be Aware of Prepayment Charges

While many adjustable-rate home loans do not levy prepayment charges, fixed-rate loans often do, especially if the prepayment is funded through refinancing.

A typical penalty could be 2% of the prepaid amount. Using your own funds for prepayment generally avoids these charges. Always check with your lender about potential penalties before making a decision.


How to Calculate the Right Home Loan Prepayment Amount and Interest Rate?

Let’s calculate the right prepayment amount and interest rate for a home loan.

Step 1: Determine Prepayment Impact

We’ll calculate the impact of different prepayment amounts on the loan for each year.

Prepayment ScenarioPrepayment Amount (INR)New Loan Term New Monthly EMI (INR)Total Interest Paid (INR)Total Interest Saved (INR)Time Saved 
Scenario 11,00,00015 Years47,63243,13,85010,29,2125 Years
Scenario 22,00,00010 Years52,24339,30,91213,12,15010 Years
Scenario 33,00,0005 Years57,09235,91,15016,51,91215 Years

Step 2: Calculate Interest Rate Savings

Now, let’s explore how refinancing at lower interest rates might impact the loan.

Refinancing ScenarioNew Interest RateNew Monthly EMI (INR)Total Interest Paid (INR)Total Interest Saved (INR)Monthly EMI Change (INR)
Scenario 17.5%45,17040,30,45711,71,605-Rs 2,221
Scenario 27%44,46038,87,39212,78,670-Rs 2,931

By comparing these scenarios, you can determine the right prepayment amount and interest rate for your home loan.


Real-Life Scenarios: Strategic Prepayments & Interest Rate Adjustments

Check out these real-life scenarios of strategic home loan prepayments.

Scenario: Strategic prepayments on a mortgage in India

Let’s say Rahul and Priya have taken a 25-year home loan of Rs 20,00,000 with an interest rate of 8% per annum. They want to explore strategic prepayments to minimize the overall interest paid and shorten the loan tenure.

Rahul and Priya decide to make an additional payment of Rs 5,000 towards the principal amount of their home loan every month. They set up an automatic payment system to ensure consistency and discipline in their prepayment strategy.

They will get the mentioned benefits

By consistently making extra payments towards the principal amount, Rahul and Priya can reduce the total interest paid over the loan period, given that home loan interest rates in India can be relatively high.

Prepayments enable Rahul and Priya to pay off their home loan much sooner than the original 25-year term, saving them both interest costs and relieving them from long-term debt obligations.

Early loan repayment frees up Rahul and Priya’s monthly cash flow, allowing them to pursue other financial goals such as investments, savings, or lifestyle improvements.

Additional Case Studies

Scenario 2: Interest rate adjustment through refinancing in India

Aarushi holds a 5/1 adjustable-rate mortgage (ARM) with an initial fixed rate of 9% for the first five years. As the initial fixed-rate period nears its end, Aarushi seeks to adjust her interest rate to avoid potential rate hikes.

Aarushi opts to refinance her mortgage to secure a lower fixed interest rate for the remaining loan term. After exploring various options, she finds a refinancing deal offering a fixed rate of 8.5%, effectively reducing her monthly payments and overall interest costs.

She will receive the following benefits

By refinancing to a lower fixed interest rate, Aarushi enjoys stable monthly payments throughout the remainder of her loan term.

The reduced interest rate leads to significant savings over the life of the loan compared to potential rate hikes with her previous ARM.

Aarushi gains peace of mind knowing that her mortgage payments are predictable and manageable, reducing financial uncertainties.

Make sure paying off your loan early is the right decision. Talk to our advisors now!

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Conclusion

If you have any queries or doubts regarding home loan interest rates and how you can get best home loans, you can opt for personalized guidance from Credit Dharma.

Choosing Credit Dharma for your home loan needs offers distinct advantages. Firstly, it provides impactful services without any hidden charges. Secondly, Credit Dharma unlocks benefits to help you save money, achieve loan freedom faster, and fulfill all your housing finance requirements seamlessly.

With competitive rates starting at 8.50% annually, Credit Dharma ensures quick loan processing, lifelong support, and a spam-free experience for customers, facilitating savings and faster loan freedom.


Frequently Asked Questions

What is prepayment and why is it important?

Prepayment refers to paying off a portion of the principal loan amount before the scheduled due date. It helps reduce the total interest paid over the loan term and shortens the loan duration.

How to calculate the right prepayment amount?

Determine the amount you can afford to prepay without financial strain. Consider factors like your budget, available savings, and any prepayment penalties imposed by the lender.

What is the impact of prepayment on the loan term and interest paid?

Prepayment reduces the outstanding principal balance, which can shorten the loan term and decrease the total interest paid over time.

How to calculate the interest rate for a home loan?

The interest rate is typically provided by the lender based on factors such as creditworthiness, loan term, and prevailing market rates. You can use online calculators or consult with lenders to estimate your potential interest rate.

Can I negotiate the interest rate with the lender?

Yes, you can negotiate the interest rate with the lender. Factors such as your credit score, loan amount, down payment, and financial stability may influence your ability to negotiate a lower interest rate

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