What is the Principal Amount in a Home Loan?

Ever wonder why some folks breeze through their mortgage payments while others seem to struggle? A lot of it boils down to one key element: the principal amount. If you’re curious about how this could affect your home buying experience, you’re in the right place. Let’s demystify this crucial term together and discover how it shapes the path to owning your dream home.

What is the Principal Amount?

The principal amount is simply the total amount of money you borrow from a bank when you take out a home loan. This is the core sum that you agree to repay over the life of the loan, and it doesn’t include any of the interest or additional fees that might accumulate over time. 

For example, if you buy an apartment priced at ₹50 lakhs and decide to make a down payment of 20%, which amounts to ₹10 lakhs, you will need to borrow the remaining ₹40 lakhs from a bank or financial institution.

This borrowed amount of ₹40 lakhs is the principal amount of your home loan. Over the term of the loan, which might typically be 20 years with an interest rate, say, of 7.5% per annum, you will need to repay this ₹40 lakhs along with the accrued interest.

The lender calculates your monthly payments based on the principal amount and the interest rate, determining how much you will pay in total by the end of the loan term.

How the Principal Amount Influences Your Home Loan Repayment

Monthly Instalments:

• You use the principal amount to calculate your Equated Monthly Instalment (EMI).
• Lenders calculate the EMI based on the principal, interest rate, and loan term.
• A larger principal generally results in higher EMIs.

Total Interest Paid:

• You calculate interest on the remaining principal.
• A larger principal leads to more interest accruing over the loan term, assuming the interest rate and loan term remain constant.

Loan Term:

• The principal amount affects your loan duration.
• A higher principal might lead you to choose a longer repayment period, increasing total interest paid.
• You can shorten the loan term by reducing the principal faster.

Amortisation Schedule:

• You review the amortization schedule to see how much of each payment goes towards the principal and interest.
• In the early years, your payments mostly cover interest, but as the principal reduces, more of your payment goes towards reducing the principal.

Refinancing Options:

• You may qualify for better refinancing terms if you significantly reduce the principal due to a lower loan-to-value ratio, which lenders view as less risky.

Prepayment Benefits:

• By making prepayments, you reduce the principal, decreasing the total interest paid over the loan term and potentially shortening the loan duration.
• Consider potential prepayment penalties when calculating the benefits of early repayment.

Smart Strategies to Reduce Your Home Loan Principal Amount Faster

Strategy	How to?
Increase EMI	Consider slightly raising your Equated Monthly Instalment (EMI). Even small increases can significantly reduce the principal and cut down on long-term interest costs.
Make Bi-Weekly Payments	Split your monthly EMI into two half-payments every two weeks. This strategy results in making 26 half-payments per year, equivalent to 13 full payments, thereby reducing the principal faster.
Lump Sum Payments	Use any unexpected income, like bonuses or tax refunds, to make one-time large payments toward your principal. This can make a notable impact on reducing your loan balance.
Refinance Wisely	If market interest rates have fallen, consider refinancing your home loan to take advantage of lower rates. A lower interest rate can mean lower EMIs, allowing you to allocate more funds toward reducing the principal.
Opt for Shorter Loan Tenure	Choosing a shorter loan period usually means higher EMIs, but you’ll pay less in total interest and reduce your principal faster.
Avoid Prepayment Charges	Check if your loan agreement includes prepayment penalties. If there are no hefty charges, make additional lump sum payments to reduce the principal without extra costs.

Tax Benefits on Home Loan Principal Amount: Section 80C

The Indian Income Tax Act offers several deductions to ease the financial burden on taxpayers, particularly those related to housing loans. One such provision is the deduction on principal repayment under Section 80C. This section allows taxpayers to claim a deduction on the principal portion of the home loan EMIs paid during a financial year, up to a maximum limit of ₹1.5 lakh.

Conditions for Claiming the Deduction

To claim this deduction, several conditions must be met:

1. Completion of Construction: The deduction under Section 80C can only be claimed once the construction of the house is complete. If you are paying EMIs on a loan taken for an under-construction property, the principal repayment during this period is not eligible for deduction.
2. Ownership of the Property: You must be the owner of the property for which the loan was taken to claim the deduction. If the loan is in another person’s name, you cannot claim the deduction, even if you make the payments.
3. Possession of the Property: You must have taken possession of the property to be eligible for the deduction. If the property is under construction, no deduction can be claimed until you receive the possession certificate.

The Five-Year Rule: Ensuring Long-Term Ownership

To claim the deduction on principal repayment under Section 80C, you must not sell the property within five years of possession. This rule ensures that you genuinely intend to retain the property rather than selling it for short-term gains.

What Happens When You Sell the Property Within Five Years?

If you sell the property within five years from the date of possession, you must reverse any deductions claimed under Section 80C for the principal repayment. You will need to add the total deductions claimed in previous years back to your income in the year of sale. This amount will be taxed according to your income tax slab rate.

For example, if you claimed a total of ₹4.5 lakh under Section 80C over three years and then sold the property in the fourth year, you must add this ₹4.5 lakh back to your income in the fourth year, potentially increasing your tax liability significantly.

Conclusion

As we close the chapter on principal amounts, remember: knowledge is your best ally in mastering your mortgage. When you clearly understand how your principal amount works, you can make smarter choices that lead to significant savings and a quicker path to debt freedom.

Curious about optimising your loan strategy or considering refinancing? Let Credit Dharma guide you through your options with expert advice tailored to your unique situation. Take the first step towards smarter home loan management with Credit Dharma. Your financial freedom awaits!

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