Nirav Shah (35 years) of Mumbai had taken a loan of Rs 40 lakh in 2015 at the rate of 8.5% for a period of 30 years. Initially, I stuck to the amortization schedule and was paying installments of Rs 31,000 per month. However, he soon realized that a major part of his monthly income was going towards loan repayment.
To overcome this challenge, Shah adopted the strategy of loan prepayment from the second year, so that he could repay the loan in 5 years. However, Shah is not the only person to do so. Many people taking home loans make extra efforts to reduce their debt burden, so that they can get relief in the initial phase.
Interest can be reduced in the initial years
Pranav Gupta (32 years), resident of Ahmedabad, has taken a loan of Rs 75 lakh at 8.5 percent interest rate, which he had planned to repay in 25 years. He has a joint home loan with his wife and together they pay an installment of Rs 60,392 every month. During the loan period, Gupta will pay interest of Rs 1.06 crore in addition to the principal amount and thus his loan amount will be doubled.
If the home loan amount had been 9% or 9.5%, the interest would have increased to Rs 1.14 crore or Rs 1.22 crore. If prepayment of loan is to be made, it should be done as soon as possible. Adil Shetty, CEO, Bankbazaar.com, said, ‘In fact, interest forms a major part of your EMI in the initial years and prepayment will mean more savings.’
Assume that a loan of Rs 50 lakh has been taken at an interest rate of 9% per annum for a period of 20 years. A total interest of Rs 58 lakh will be payable on the loan. If you make an advance payment of Rs 5 lakh in the first year (13th month) of the loan, the interest amount will reduce to Rs 40.4 lakh. In this way you will have a budget of Rs 17.6 lakh. However, if you pay Rs 5 lakh in the 10th year (121st month), the total interest savings will be just Rs 6.1 lakh.
Use bonus and surplus for home loan prepayment
Whenever you get some amount through bonus, tax refund, windfall gain etc., you should use it for prepayment of home loan. Krishna Mishra, CEO of FPSB India, the Indian subsidiary of the American unit Financial Planning Standards Boards Limited, said, ‘With the help of this strategy, the principal amount gets reduced directly and the interest expenses are reduced. Besides, the loan tenure also reduces. However, it is not advisable to use retirement funds for this. In fact, doing so will create difficulties for retirement planning.