The home that you have purchased is probably the biggest asset that you will ever have, but if you have bought it on a home loan, you must also realize that it is the biggest debt that you have. Home loans are long tenure loans and the interest you pay on them is much higher than your principal amount borrowed. For instance, if you have taken a Rs. 60 lakh loan for a tenure of 20 years at an interest rate of 10% you end up paying an interest of Rs 78,96,240 on it. Therefore the actual cost of your home works out to be Rs 1, 38,96,240.

If you haven’t considered this colossal interest payment yet, it’s time for you to wake up and smell the coffee! Once, you realize that you are spending so much money on the interest component, you would obviously look for a solution to bring down the total cost of your loan. The solution lies right in front of you! It is called partial pre-payment on your home loan. Most of the lenders in our country allow you to make monthly pre-payments. Let us consider some of its advantages and disadvantages.

Advantages of prepayment

Interest payment savings: This is the most obvious advantage of prepaying your loan. All financial advisors would tell you that when you prepay even a small amount it goes towards the principal payment of your loan and as the principal amount reduces, so does the interest amount. Common wisdom says that every surplus that you have such as a salary hike or a bonus payment, it should go towards the payment of your home loan, but it may not be possible to do that always. Instead, you could consider saving a small amount of money every month on other expenses and use it towards pre-payment over and above your EMI.

Let’s understand this with our previous example of a Rs. 60 lakh loan with a 10% interest for a loan tenure of 20 years. Your EMI for the same is Rs. 57,901. If you do not make any pre-payment the total cost of your home works out to be Rs 1, 38, 96,240. Now, if you were to make a small pre-payment of Rs. 2,000 from the 6th month of your loan tenure (effectively paying Rs. 24,000 each year), you could save a total of Rs. 8,53,962 and bring down your loan tenure by 1 year 10 months. Look at the tables below to understand better:

 No prepayment penalty: In June 2012, the Reserve Bank of India abolished prepayment penalty on all floating rate home loans, making life easier for borrowers. Some banks, however, have a lock in period of six months before which you cannot start making prepayments towards your loan.

Disadvantages of prepayment

Losing out on an opportunity cost: Before considering prepayment you should ensure that there is no other financial instrument in the market that would have given you a higher rate of return than the interest rate that you are paying on your home loan.

Lack of diversification: Your property will comprise a lion share of assets. By prepaying your mortgage loan, you are not increasing any investments (although you are lowering debt). If you choose not to prepay, you can invest in other asset classes and thereby reduce your risk of exposure to a single asset class.

Although it is up to you to decide what is the best thing to do, the pros of prepayment outweigh the cons as you will end up being debt free faster and there are no other risk free financial instruments that offer guaranteed returns that are higher than the rate of interest you will pay on your home loan.