A home loan is usually the biggest debt that a person takes on during a lifetime. Given a long tenor and high amount of loan, the total interest you pay to the lender is almost as big, if not bigger, as the loan amount itself. For instance, you pay a total interest of Rs. 65.8 lakh on a loan of Rs. 50 lakh taken over a tenor of 10 years with an interest rate of 10% per annum.
If you had never calculated your the total interest you pay and the figure comes as a shock for you, here’s a way to lessen the pain if not remove it completely: part prepayment.
Don’t stop reading further if you think you don’t have a lumpsum to pay off your loan or enough surplus to increase your equated monthly installment (EMI) substantially. We are not suggesting either of the two ways. Numbers we ran showed that that even part prepayment with an amount as low as Rs. 1,000 can help you save a substantial amount in the long run. Besides, it also helps you reduce the tenure of the home loan.
How do small savings make a large difference?
When you choose to prepay the loan, even if it’s a smaller amount, you actually attack the root of the problem. “Every time you make a part prepayment towards your loan, the amount goes towards repaying the principal amount of the loan,” said Adhil Shetty, CEO, Bankbazaar.com, a loan portal. “As the principal amount you owe reduces, so does the interest amount.”
So if you have even a small surplus, you should repay the principal part of the home loan. The truth is that not everyone can afford to part pay an entire EMI amount as an additional part prepayment. However, even if you are able to set aside a few thousand rupees every month, it would work well for you. Here are some numbers to show that. Assume you have a loan of Rs. 50 lakh for a tenure of 20 years at 10% per annum interest rate. We took five scenarios, wherein you could pay Rs. 1,000, Rs. 2,000, Rs. 3,000, Rs. 4,000 or Rs. 5000 every month as a part prepayment amount, over and above the regular EMI amount. Even if you pay Rs. 1,000 a month, you would save an amount of Rs. 4.7 lakh and get to reduce the loan tenure by 1.2 years. (see table).
What to consider before part prepaying a loan?
The most important aspect to consider before you actually start part prepaying is ensuring that there is no guaranteed instrument in the market that is giving a higher return than the home loan interest rate. If there is such an instrument, you would earn more in terms of savings by investing in it instead of part prepaying your loan.
“Today the interest rate on home loans is around 10.50-11% per annum and there is no other risk-free instrument that offers a guaranteed return that is higher than that,” said Shetty. . “If you have the money, you should go ahead and prepay or part prepay the loan.”
options that banks offer In our example, we’ve considered monthly part prepayment. However, many banks allow you to make part prepayment multiple times in a year.
“HSBC home loan customers have the option to make multiple part prepayment through the year,” said Says Manish Sinha, head (consumer assets), HSBC India. “There is no upper limit on the number of times they wish to prepay. There is no minimum amount restriction for making any such part prepayment.”
Banks including State Bank of India (SBI) and Axis Bank Ltd do not have restrictions. Some banks have a lock-in period after which you can start prepaying. For example, Kotak Mahindra Bank Ltd allows you to pre-pay after a lock-in period of six months.
A few banks allow you to part pay only few times a year. For instance, as per IDBI Bank Ltd's website, they allow part prepayment four times a year.
Is there a cost?
Last year, the National Housing Board had directed all housing finance companies to do away with prepayment penalties for loans with floating rates. In fact, even the Reserve Bank of India in its annual policy announcement for 2012-2013 directed banks to not levy any prepayment charges for home loans taken on floating rate. Detailed guidelines in this regard are expected soon.
In fact, some lenders, including SBI and Axis Bank, have waived such prepayment charges. “You will have to bear a small charge to set an electronic clearing service or standard instructions charges,” said Siddharth Gupta, co-founder, GNBindia.com, a group buying portal for loans. “Most major banks will not charge any other transaction charge.”
With no prepayment charges on floating rate home loans, paying off regularly will save you money and reduce the loan tenure. In fact, even if your lender allows you to pay only once a quarter or two to three times a year, you will find a difference in the total interest paid and the loan tenure. So if you have a home loan, take that small step now.