A home loan makes it possible for many people to buy a house at an early stage of life. At the same time, not everyone wants to carry a loan for 20 or 30 years. As income grows with career progression, some borrowers prefer to repay the loan faster and reduce the total interest outgo.
One way to achieve this is through home loan part payments.
In this article, we will explain what a home loan part payment is, how it helps reduce interest over time, when it is most beneficial to make a part payment, and whether reducing the EMI or the loan tenure can lead to greater interest savings.
What Is a Home Loan Part Payment and How Does It Reduce Interest?
A home loan part payment is a lump-sum amount paid directly towards the outstanding loan principal, apart from the regular EMIs. Borrowers can make part payments when they receive extra funds, such as an annual bonus, fixed deposit maturity proceeds, or other savings.
Unlike a regular EMI, which is divided between interest and principal repayment, the entire part payment is adjusted against the outstanding principal amount, reducing the total loan balance by the amount prepaid. Since home loan interest is calculated on the outstanding principal amount, the reduced loan balance results in lower total interest payable over the remaining loan tenure.
After making a part payment, borrower gets two options:
- Either reduce the EMI while keeping the loan tenure unchanged, or
- Keep the EMI unchanged and reduce the loan tenure
The option chosen can influence the total interest paid over the life of the loan.
EMI Reduction vs Tenure Reduction: Which Saves More Interest?
The choice between EMI reduction and tenure reduction often comes down to improving monthly cash flow or maximising interest savings over the remaining loan tenure.
Reducing the EMI lowers the monthly repayment amount, which can improve cash flow and make future repayments more manageable, while the loan continues for the original tenure.
Keeping the EMI unchanged and reducing the loan tenure generally results in greater interest savings. Since the loan is repaid over a shorter period, interest is charged for fewer months, helping reduce the total interest payable over the remaining tenure.
Use a home loan EMI calculator to check whether reducing the loan tenure while keeping the EMI unchanged fits the monthly budget or whether opting for EMI reduction would be a more suitable choice.
Why Early Home Loan Part Payments Can Save More Interest
The timing of a home loan part payment can make a significant difference to the total interest savings.
In the initial years of a home loan, a larger portion of each EMI goes towards interest, while a smaller portion is used to repay the principal. Making a part payment during this period reduces the outstanding principal earlier in the loan tenure. A lower principal means less interest is charged on the remaining loan balance over the years ahead, leading to higher overall interest savings.
Making a part payment at a later stage of the loan can still reduce the outstanding loan balance and lower future interest. However, with fewer repayment years remaining, the overall interest savings may not be as significant as those from an early part payment.
When Is a Home Loan Part Payment Beneficial?
Apart from making a part payment during the initial years of the loan, borrowers should also consider a few other factors before making the decision.
A part payment is beneficial when the interest saved over the remaining loan tenure is higher than any applicable prepayment charges, if any.
Borrowers should also avoid using emergency savings or funds meant for essential expenses to make a part payment. Doing so may disrupt cash flow and lead to additional borrowing in the future, which could come at a higher cost.
Individual borrowers with floating-rate home loans can benefit from part payments, as lenders cannot charge any prepayment fee on such loans under RBI guidelines.
Final Thoughts
Home loan part payments can be an effective way to reduce the total interest paid over the loan tenure. Making them during the early years of the loan and choosing the right repayment option can increase the overall benefit. At the same time, maintaining sufficient savings for future needs is equally important for long-term financial well-being.
