Prepayment of a loan : Business Line

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I have a loan of Rs 20,00,000 for a 15-year repayment period. I want to pay some amount to reduce the loan amount. Is it advisable to reduce the EMI or the period of payment?

— Muthu S

You haven't specified at what interest rate you have taken your loan or the EMI amount you are repaying your loan with. This would have helped us calculate the exact amount of savings you would be eligible for if you opt to prepay your loan.

When you prepay your loan, it directly affects the outstanding principal amount, which is a good thing, as the loan amount you borrowed itself gets reduced. Usually, when you prepay, the loan tenure gets decreased by default, unless you specifically approach the bank to reduce your EMI instead. The best approach would be to opt to decrease your loan tenure, as in this way, you will be able to significantly save on the outgoing interest cost on the loan. Reducing your EMI may be counter-productive.

Let's understand this better with an assumption that your current interest rate is 11 per cent for a Rs 20-lakh loan with a 15-year tenure.

If you prepay an amount of, say, Rs 15,000 every six months, from sometime around the third year onwards (most banks specify a time limit before which you can start prepaying your loan) you will save around Rs 3.7 lakh on the interest cost of the loan, and also reduce your loan tenure by two-and-a-half years.

In conclusion, when you prepay, reducing your tenure is a better option than reducing your EMI, as this helps to save on interest cost.