Banks allow customers to pre-pay loans. Pre-payment helps the customer to reduce the outstanding amount and thereby reducing the interest burden and also finishing the loan earlier than its normal schedule. Pre-payment can be done in two ways: pre-paying a lump sum amount at a time or increasing the EMI (5% or 10% or whatever % the customer is comfortable with). Let us explore the two options.

If the customer gets a onetime cash flow, he can use that to make a lump sum pre-payment and reduce the outstanding balance on his home loan. For example in case of Suresh if he gets an annual bonus from his employer or maturity proceeds from a bank fixed deposit (FD) or National Saving Certificates (NSC) or insurance maturity proceeds then he can use this amount to make a pre-payment and reduce the outstanding amount on his home loan. By making a pre-payment the customer has 2 options:

Reducing the loan tenure :

The customer can make a lump sum pre-payment and reduce the tenure of his home loan and keep the EMI same. Let us see how this will work in Suresh’s case. Let us assume that Suresh gets a onetime cash flow of Rs. 5 lakhs from the maturity of his National Savings Certificates (NSC). If he makes a pre-payment of Rs. 5 lakhs it will reduce his outstanding amount from Rs. 24.50 lakhs to 19.50 lakhs. Suresh can ask the bank to keep his EMI same at 24,043 and reduce the tenure of the loan. In such a scenario the tenure of Suresh’s loan will reduce from 19 years (228 installments) to 11 years (136 installments). Suresh’s installments will get reduced by 92 installments.

Reducing the EMI :

The customer can make a lump sum pre-payment and reduce the EMI of his home loan and keep the tenure same. Let us see how this will work in Suresh’s case. Let us assume that Suresh gets a onetime cash flow of Rs. 5 lakhs from the maturity of his National Savings Certificates (NSC). If he makes a pre-payment of Rs. 5 lakhs it will reduce his outstanding amount from Rs. 24.50 lakhs to 19.50 lakhs. Suresh can ask the bank to reduce the EMI on the loan and keep the tenure same at 19 years. In such a scenario the EMI on Suresh’s loan will reduce from Rs. 24,043 to Rs. 19,137 and the tenure of the loan will remain same at 19 years.

Every individual expects his salary to increase by 5% or 10% every year. So the person can use this increased cash flow to lighten his loan burden. Suresh can ask his bank to increase his EMI by 5% compounded every year. In such a scenario Suresh’s current EMI will increase from Rs. 24,043 to Rs. 25,245 and subsequently go on further increasing by 5% every year. In such a scenario Suresh will be able to repay his remaining outstanding loan amount in 11 years (130 installments) instead of 19 years. Suresh will be able to service his loan in 130 installments instead of 228 installments (19 years) and reduce 98 EMI’s. Some banks do not allow the customer to increase the EMI. In such a scenario Suresh can take the difference between the increased EMI (Rs. 25,245) and original EMI (Rs. 24,043) i.e. Rs. 1202 and put it in a monthly recurring deposit. The customer can then use this money to make lump sum pre-payment at the end of the year. The customer can follow this practice every year till the loan gets over.

Suresh also has the option to increase his EMI by 10%. In such a scenario Suresh’s current EMI will increases from Rs. 24,043 to Rs. 26,447 and subsequently go on further increasing by 10% every year. In such a scenario Suresh will be able to repay his remaining outstanding loan amount in 8 years (100 installments) instead of 19 years. Suresh will be able to service his loan in 100 installments instead of 228 installments (19 years) and reduce 128 EMI’s. Some banks do not allow the customer to increase the EMI. In such a scenario Suresh can take the difference between the increased EMI (Rs. 26,447) and original EMI (Rs. 24,043) i.e. Rs. 2404 and put it in a monthly recurring deposit. The customer can then use this money to may lump sum pre-payment at the end of the year. The customer can follow this practice every year till the loan gets over.

While the customer can always make a partial lump sum pre-payment or ask the bank to increase the EMI on his loan there are few things that he should keep in mind. These include:

• • A customer should not use money reserved for other goals like child education, marriage, and retirement etc. for pre-payment of home loan.
• • When a customer asks the bank to increase the EMI by 5% or 10% every year then he should make sure that he will be able to service the increased EMI. For example if the customer increases his EMI by 10% compounded every year, then after few years the EMI may become substantially higher and the customer may find it difficult to service it.
• • To make the article simple to explain the article assumes that there will be no further rate hikes in future. But in case of floating rate home loans, the rates may increase or decrease depending on the market direction of interest rates. Once the interest rate changes, all the calculations will change.

so we have seen above how customers like Suresh can service their home loan in a better manner. A customer can:

• • Make a partial lump sum pre-payment and reduce the tenure of the loan and keep the EMI same or
• • Make a partial lump sum pre-payment and reduce the EMI of the loan and keep the tenure of the loan same or
• • Increase the EMI on the loan by 5% or 10% or any % that he is comfortable with and finish the loan before its normal schedule or
• • Use a combination of partial lump sum pre-payment and also increase the EMI every year by a certain % and finish the loan before its normal schedule.

The above mentioned all options are very flexible in nature and customers can use them depending on how comfortable they are with each of them.