Best Practices for Pre-payment of Home Loan: Tips for Quicker Debt-Free Living

Today, home loans are arguably one of the quickest and safest ways to buy a house. All you need to do is to submit requisite documents to your chosen bank or lending institution and meet their eligibility criteria. If these institutions are satisfied with your financial credibility, the loan amount gets disbursed in a jiffy. Getting a home loan is as simple as that but paying it back with interest for a period of 20-30 years is the real deal, and to make it less burdensome, many financial experts today suggest home buyers to go for the pre-payment of home loan option.

Home loan pre-payment means repaying the loan amount either in part or full before the planned tenure. This is the way forward, if you are trying to get out of loan debt. Doing so will help you reduce the loan term or the EMI. Additionally, it will help you save money on the interest. 

Suppose you take a home of ₹50 lakh for a period of 25 years, at an interest rate of 8%. In this case, your monthly EMI will be around ₹38,591. At the end of the 25 years, the total amount that you will have paid including interest would be around ₹1.15 crore. So, you are paying ₹65.8 lakh just as interest!

During the initial repayment years, most borrowers learn that the principal amount gets paid off slowly. The first few years comes down to only paying interest.

Tenure (5-Year Period)    Paid Off Amount (in %) from Principal Amount
1    (End of 5 Years)           7.7
2    (End of 10 Years)        19.2
3    (End of 15 Years)        36.4
4    (End of 20 Years)        61.9
5    (End of 25 Years)        100

Taking the same example forward, in the 1st five-year period, you will only pay 7.7% of the total loan amount. In the 2nd five-year period, up to 19.2% of the loan would be paid off. Subsequently, by the end of 3rd five-year period, up to 36.4% loan would be paid off and by end of the 4th five-year period, this percentage increases to 61.9% of the total amount. Finally, at the end of the 5th five-year period, the entire principal amount would be re-paid. This is exactly why it is wise to pre-close home loan so as to get relief on the interest upon the principal amount.

Tips on Foreclosure of Home Loan

The best way to foreclose a loan is to make maximum repayments from the beginning and completely close it within a few years. However, few banks and lending institutions may levy certain fee for early foreclosure. However, it is still fine to pay the penalty fee than paying the interest because at least, you will be debt free and can spend your money on other important things. So, whether you are going for full or part prepayment of home loan, these are some of the tips that will come in handy:

⦁    Begin with small prepayments
⦁    Go for higher EMI
⦁    Fixed Prepayment
⦁    Higher down payment
⦁    Increase EMI amount
⦁    Extra EMI Payment
⦁    Using MFI/Bonds/FD

1.    Begin with Small Prepayments

One of the methods of pre-payment is to start with small amounts in the beginning, and then aggressively increase it year-on-year at a constant rate. This you can do by putting aside a certain amount throughout the year, only for this purpose.

2.    Go for Higher EMI

Another advisable option is to paying a little more than the EMI amount, each month. This would clearly decrease your principal loan amount part-by-part and go a long way in lowering the debt.

3.    Fixed Prepayment 

For each year, you can plan to repay a certain lump sum amount. This should be above your EMI installments. This is one way you can pre-pay the principal amount quickly.

4.    Higher Down Payment

Financial experts suggest the higher down payment method is one of the best ways of home loan pre-payment. This has to be done at the beginning, where you are repaying a substantial amount of the loan. This cuts a big chunk from the principal meaning your loan term can now be less and so the interest rate. 

5.    Increase EMI amount

A salaried person is more likely to get an annual raise each year. This means extra income over the previous year. Now, this additional income can be used to increase the EMI amount by a small percentage. This may be a small step but can eventually help in decreasing the interest in the long run.

6.    EMI payment 

Besides annual raise, salaried persons are also likely to get certain bonuses from time-to-time as a reward for their work. This bonus amount can be used to pay the extra EMI – one to repay the loan faster and second to save on the interest amount.

7.    Using MFI/Bonds/RD/FD

Another way is to accrue a substantial amount to pre-pay a home loan through investing in mutual funds, bonds or by creating recurring or fixed deposit funds with an aim to use this maturity money for foreclosure of the home loan. Investing in these portfolios will not only help you save but also get you interest on it that you can divert to repay the loan.

Why to go for Loan Prepayment?

The most common answer is saving on the interest but there is more to it. Prepaying home loans is advisable because then a person is free from any financial baggage later in life. What if there is a major health issue with any of the family member? This becomes an urgent situation, and nobody would want to give priority to the home loan EMIs. Higher education of children could also be another factor, where no parent would want to compromise because of financial constraints. Retirement is another aspect that cannot be ignored, and anybody would want to live a debt-free life after 60 because there would be no flow of income on a monthly basis. 

Therefore, most people today are opting for the foreclosure option keeping their future responsibilities and costs in mind. However, you must keep in mind that just to prepay the loan amount you need not mortgage your valuable assets at any given point of time. Pre-payment of home is the best option for borrowers, but it has to be done in a strategic and timely manner.