Home Loans: Why Adding EMI or Partial Advance Makes Sense (2023)

Various home loan prepayment options like increasing EMI by 5%-10% per annum or partial prepayment of Rs 50,000 or Rs 1,00,000 per annum can significantly reduce your interest payments and loan tenure.

Owning a house is one of everyone's greatest desires. However, most people cannot buy a home with a down payment due to high real estate prices. They must be dependent on housing loans, and the terms of the loans are up to 20 years. This article will explain how individuals can prepay their home loan through different home loan prepayment options.

What is early repayment of a housing loan?

Home loan terms can vary from 5 to 20 years or even longer. Most people opt for the longest term they are eligible for in order to keep their Equivalent Monthly Installment (EMI) as low as possible.

Early repayment of a home loan is the process of paying off a home loan before the usual term of 20 years. This can be done by using different home loan prepayment options like adding EMI or lump sum or a combination of both. Namely, as per RBI guidelines, banks cannot impose a late fee/early repayment penalty on individual borrowers on a variable rate home loan. So, if you have funds left, it makes sense to pay back part of the housing loan on time.

Possibility of early repayment of housing loans

Suppose Amit applies for a home loan of 5 lakh rupees at 6.75% p.a. term of 20 years. It will pay an EMI of Rs 38,018. Amit's total payment over 20 years will be Rs 91,24,365, including principal repayment of Rs 5 crore and interest payment of Rs 41,24,365.

As for the home loan repayment, Amit has two options: either continue paying the regular EMI for 20 years or choose one of the various home loan prepayment options. In this article, we'll look at four prepayment options:

• EMI increases by 5% per annum
• Rs 50,000 in advance at the end of every year
• EMI increases by 10% per annum
• Rs 1,00,000 in advance at the end of every year

Let's see how each of the above prepaid options works and what benefits Amit will get if he chooses them.

related:Know your EMI well. Are you paying more than you should?

1) EMI increases by 5% per annum

Most receive annual raises during performance reviews. They can use the extra monthly cash flow to increase their home loan EMI.

For example, Amit can increase the monthly EMI at the beginning of every year at the rate of 5%. In our example, his initial EMI is Rs 38,018. From the second year, he can increase the EMI by 5% per annum as follows:

• Second Year EMI: INR 39,919
• Third Year EMI: INR 41,915
• 4th year EMI: Rs 44,011
• Fifth year EMI: Rs 46,211 and so on.

By opting for an EMI increase of 5% p.a., Amit can enjoy the following benefits on his home loan:

• Reduce the amount of EMI:Amit will be able to settle the home loan in 152 EMI installments instead of the usual 240 installments. This saves him 88 EMI installments.
• Save on interest:Amit will pay interest of Rs 27,71,482 instead of regular interest of Rs 41,24,365. Hence, he will save Rs 13,52,883 in interest.

2) Advance of Rs 50,000 at the end of every year

Many receive annual bonuses as part of performance reviews or Diwali bonuses. They can use this lump sum to prepay a portion of their home loan every year. As mentioned in the previous section, some banks may not allow an increase in EMI. In this case, home loan borrowers can set aside some money every month as a fixed deposit.

Amit can use his annual bonus to prepay part of his home loan. If he does not get any annual bonus, he can start making fixed deposits of Rs 4000 per month in the bank. After 12 months, he will get 48,000 rupees plus interest. If there is a shortfall, he can make up Rs 50,000 from his own pocket. Every year, Amit can use Rs 50,000 to prepay part of his home loan.

By opting to make a partial prepayment of Rs 50,000 at the end of each year, Amit will enjoy the following benefits of his home loan:

• Reduce the amount of EMI:Amit will be able to settle the home loan in 198 EMI installments instead of the usual 240 installments. This will save him 42 EMI installments.
• Save on interest:Amit will pay interest of Rs 33,08,561 instead of regular interest of Rs 41,24,365. Hence, he will save Rs 8,15,804 in interest.

note:Borrowers have the option of reducing the EMI of the loan or the term of the loan by paying a lump sum. In the above example, suppose Amit decides to keep the EMI constant and decides to reduce the loan term.

3) EMI increases by 10% per annum

Some people who excel in their careers or work in emerging industries earn higher annual salary increases than others. These individuals have the option of increasing their home loan EMI at a compound rate of 10% per annum. Instead of the 5% per year discussed in the previous section.

Let's see what happens if Amit adds a monthly EMI at a compound rate of 10% p.a. at the beginning of each year. For example, its starting price is 38,018 rupees. From the second year, he can increase the EMI by 10% per annum as follows:

• Second year EMI: INR 41,820
• Third year EMI: INR 46,002
• Fourth year EMI: Rs.50,602
• Fifth year EMI: Rs 55,662 and so on.

By opting for a 10% annual EMI increase, Amit will enjoy the following home loan benefits:

• Reduce the amount of EMI:Amit will be able to complete the home loan in 120 EMI installments instead of the usual 240 installments. This will save him 120 EMI installments.
• Save on interest:Amit will pay interest of Rs 22,58,003 instead of regular interest of Rs 41,24,365. Hence, he will save Rs 18,66,362 in interest.

related:5 reasons for refinancing a mortgage

4) Advance of Rs 1,00,000 at the end of every year

As mentioned earlier, many get annual performance bonuses or Diwali bonuses. They can also start with a fixed deposit of Rs 4,000 per month and accumulate Rs 50,000 per year. A combination of the annual bonus with a fixed amount of deposit will create a fund of Rs 100,000 per year.

If you don't get the annual bonus, you can start with a fixed deposit of Rs 8000 per month and accumulate Rs 1 lakh at the end of the year. This amount can be used to pay off a portion of the home loan of Rs 1 lakh in advance at the end of each year.

Let's see what happens if Amit prepays his home loan of Rs 1 lakh at the end of every year. They will receive the following benefits:

• Reduce the amount of EMI:Amit will be able to settle the home loan in 168 EMI installments instead of the usual 240 installments. This will save him 72 EMI installments.
• Save on interest:Amit will pay an interest of 27,83,661 rupees instead of the regular interest of 41,24,365 rupees. Hence, he will save Rs 13,40,704 in interest.

note:Borrowers can choose to reduce the loan EMI or the loan tenure when paying a lump sum. In the example above, suppose Amit decides to keep the EMI unchanged and shorten the loan tenure.

Possibilities of early repayment of a housing loan: an overview

In the section above, we have explored the various home loan prepayment options available to Amit and the benefits he will get from each option. Now let's summarize these four:

note:To make the concept of early mortgage repayment easier to understand, the table above assumes that the mortgage interest rate does not change during the term of the loan. In real life, however, most home loans are variable rate loans, where the interest rate adjusts as market interest rates change. So all subsequent calculations will change in line with the changed interest rate when the interest rate changes.

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Things to keep in mind when paying off your mortgage early

Avoid diverting money invested in financial goals to prepaid home loans
Some people may not be able to increase the EMI by 5% or 10% per annum. But at some point, especially at a 10% compound EMI, the EMI may become large enough to manage the cash flow. At this stage, you can continue to use the previous year's EMI in future years.
If the compound payment is difficult to bear, individuals can also consider adding a simple rate of 5% or 10% per annum on the EMI instead of the compound rate.

the last word

As we have seen, people can realize significant benefits by prepaying their home loans. We have considered four options for early repayment of a housing loan that you can choose according to your financial situation. You can even customize these prepayment options to suit your requirements. The idea is to pay off your mortgage as quickly as possible, as this can save you a lot of money.