When you take a home loan, it is structured in such a manner that during the initial years of the loan, the interest component in the EMI is larger. But this gradually decreases as time goes on. So ideally, the earlier you prepay a loan, the better. That way, there is a bigger impact on the total interest cost as the money you prepay goes straight towards reducing the home loan principal.
Now, with loan rates breaching 9 percent for many, borrowers are no doubt feeling the burn from the increased interest costs. And given that rates are now higher than what many safe debt instruments offer, there is a case to begin prepayments if you can manage them.
Of course, there is a home loan tax benefit angle that reduces the effective post-tax home loan rates. But still, for most people, loans are a burden best rid of at the earliest. So, at least for them, this might be a good time to look at a one-time and/or periodic prepayments.
Also read – Best time for home loan prepayment
How to begin prepaying your home loan
First, make sure you don’t use your emergency fund to make prepayments. You might be tempted to with a home loan at 9-9.5% and your emergency fund in an FD earning 6 percent. But don’t do that. Emergencies don’t know you’re smart and can come unannounced. So, do not make the mistake of using your contingency reserves for prepayments please.
If you have debt instruments (like surplus unallocated cash in a savings account, surplus FDs, etc.) earning much lower interest than your home loan rates, and also, as mentioned, are not part of your emergency buffer, you can use at least a part of those funds to make a prepayment. This will immediately reduce your outstanding principal and help negate the rate hike to an extent.
If your current income-expense gap allows for some leeway, then consider increasing your monthly EMIs. You can talk to your bank to have this done. Or if your bank allows for monthly prepayments, then do it yourself. This will help reduce your interest burden.
For example, on a home loan of Rs 50 lakh at 9 percent for 20 years, your EMI would be Rs 44,986. If you are able to pay 10 percent extra every month, say Rs 5,000, then your loan interest burden reduces by almost Rs 16 lakh and the loan also gets repaid in 16 years instead of 20. As you can see, just paying a bit extra every month over the years can go a long way in helping you reduce your interest burden.
Your income increases every year. So, consider increasing EMIs slightly every year. By 5-10 percent.
Use your annual bonus/incentives to prepay some amount every year. Or to look at it another way, try to pay 1-2 extra EMIs every year.
Do read about these strategies to reduce your home loan burden for elaborate examples. You can use one or a combination of the above strategies, depending on what best suits your financial situation.
Another option can be to first check your credit score, and if found to be good, then you can negotiate with your bank to reduce your loan rates by paying a small one-time fee. Or check with other lenders who might be willing to offer lower rates for a loan transfer.
If you have taken a home loan in the last year or two, I am sure you have been impacted (and a bit shocked) by the rate hikes. You should seriously consider making part prepayments to better manage your home loan if your finances allow for it. This should serve as a reminder to all that floating-rate loans work both ways; if you took advantage of a low rate when starting your loan, you should be prepared to pay a higher rate when the rates start rising.