Home Loan Prepayment: Decrease the tenure or reduce the burden of EMI? Which decision will benefit you the most..

Taking a home loan has become a common and necessary way of buying a house today. But the thought of a long loan of 20-25 years and the huge interest charged on it sometimes makes one worried. In such a situation, whenever you get a lump sum amount from a bonus, an incentive, or any other source, the first thought that comes to your mind is to repay some part of the home loan (prepayment). But as soon as you make the prepayment, the bank gives you two options - either reduce the tenure of your loan or reduce your monthly installment (EMI).

This is the question where most people get confused. Both options have their benefits, but one decision can benefit you by lakhs of rupees, while the other can lighten your monthly budget. Let us understand this with a simple calculation so that you can take the right decision for yourself.

Which decision will prove better for you? You can understand it with an example. Suppose you have taken a home loan-

Loan amount: Rs 50 lakh

Interest rate: 9% per annum

Tenure: 20 years (240 months)

On this basis, your initial EMI and total interest will be something like this:

Your monthly EMI: ₹44,986

Total you will pay in 20 years: ₹44,986 x 240 = ₹1,07,96,640

Total interest you will pay: ₹1,07,96,640 - ₹50,00,000 = ₹57,96,640

Now, suppose after 5 years (60 months) of taking the loan, you get a bonus of Rs 5 lakh, and you decide to prepay it. After 5 years, the outstanding principal of your loan is approximately ₹45,54,180. Now, if you make a prepayment of ₹5 lakh, your new outstanding principal amount will be ₹40,54,180.

Now you have two options:

Option 1: You reduce the loan tenure

In this option, your EMI will remain the same (₹44,986), but your loan will get over sooner.

New outstanding principal amount: ₹40,54,180

Your EMI: ₹44,986 (will remain the same)

New loan maturity time: Approximately 136 months (11 years 4 months)

How early your loan will get over: Your loan will now get over in just 11 years 4 months instead of the remaining 15 years (180 months). That is, 3 years 8 months (44 months) earlier.

Total savings on interest: This decision will help you save around ₹12.35 lakh on interest.

Option 2: You reduce your EMI
In this option, your loan tenure will remain the same (remaining 15 years), but your monthly EMI will reduce.

New outstanding principal: ₹40,54,180
Your loan tenure: Remaining 15 years (180 months)
Your new EMI: Approximately ₹41,125
Monthly savings in your EMI: ₹44,986 - ₹41,125 = ₹3,861 per month
Total savings on interest: This decision will help you save approximately ₹4.30 lakh on interest.
Which decision benefited you the most?
Scale Option 1 (Reduce tenure) Option 2 (Reduce EMI) Winner
Change in EMI No change (₹44,986) Reduced by ₹3,861 (New EMI ₹41,125) Option 2
Loan maturity 3 years 8 months Early maturity No change

Option 1
Total interest saved ₹12.35 lakh ₹4.30 lakh Option 1 (obviously)
Final Conclusion: Most money saved Relief in monthly budget

As you can see in the table, reducing the loan tenure is always a better decision if your goal is to save money in the long term. In this example, reducing the tenure helped you save an additional ₹8 lakh compared to reducing the EMI.

Which option should you choose?
While the calculation makes it better to reduce the tenure, the final decision depends on your individual financial situation.

You should opt for reducing the tenure if:

Your monthly income is stable and you can comfortably pay the existing EMIs.

Your goal is to become debt-free as soon as possible.

You want to save lakhs of rupees on interest.

You do not have any other costly debt (such as a personal loan or credit card bill).

You should opt for reducing the EMI if:

Your monthly income is under pressure and you want a little more money in your hand every month.

You want to invest the savings made in EMIs in a better place (such as a mutual fund SIP) where you expect to get more returns than the interest on the loan.

You want to improve your standard of living a little or need money for other important expenses like children's fees.

Overall, if your financial position is strong, then opt for reducing the tenure without thinking. It will give you the maximum financial benefit in the long term.

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