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Part prepayment: cheap loan, less tenor

india Updated: Oct 01, 2011 02:17 IST
Bindisha Sarang

If you are worried about your increased loan cost, owing to continuous rate hikes, and you are expecting a bonus this Diwali or a lump sum from some other source, here is one way to put it to good use: prepay your home loan partly.

Even those of you who are not expecting a lump sum can use the part prepayment tool by paying small amounts at regular intervals.

Numbers tell the story

Case 1: Lump sum payment (see table).
Suppose after a year of being in a loan, you make a lump sum payment of Rs 1 lakh on a loan of Rs 10 lakh taken at an interest rate of 11.0% for 20 years. Back-of-the-envelope calculations show that you will save about Rs 5 lakh in interest paid and your tenor will come down by at least five years. Here, it has been assumed that there are no prepayment charges after a year.

Case 2: Regular part payments.
In the same example taken above, if you are not able to pay a lump sum but are instead paying regularly, you will still manage to save quite a bit. Now if you pay Rs 10,000 every six months, starting from the 13th month of the loan, the net interest you pay would drop to about Rs 9.5 lakh from about Rs 14.8 lakh. Your saving comes to around Rs 5.3 lakh while your loan tenor gets reduced by six years and four months. Even if you assume a pre-payment fee of 2.0% on the sum of all prepayments made, the prepayment fee you pay is Rs 5,200. Even then, prepaying will save you Rs 5,21,209 over the same reduced tenor.

Things to keep in mind
When should you prepay? It is better to prepay in the initial years of the loan tenor since that’s when the principal outstanding is the maximum. In initial years, the principal amount constitutes a smaller part of the EMI compared with the interest part.

“Lenders usually have a six months lock-in till which you are not permitted to prepay or part pay,” said Vipul Patel, director, Home Loan Advisors (HLA), an independent mortgage advisory firm.

How much can you prepay?
Most lenders allow you to prepay 25-90% of the outstanding loan amount per fiscal year. The minimum you can part pay is usually equal to at least a month’s EMI.

How often can you prepay?
You can either part pay regularly or pay a lump sum. Prepayment can also be done on a monthly basis.

What’s the cost?
Some banks have a different penalty amounts for full prepayment and part prepayment, others have a different penalties depending on whether you close the loan with your own sources or borrow to make the prepayment. Then there are some banks, including Axis Bank Ltd and SBI, that do not charge any penalty for prepayment.

(Bindisha Sarang, Mint)