How Does Paying An Extra EMI In A Year Help You?

After buying a new house, Rekha Nigam has had to use a lot of her financial wisdom to prudently manage her household. The reason: Remove the home loan EMI (equated monthly instalment) that gets debited from her bank account automatically, besides other essential monthly bills, and there's barely anything left for Nigam to spend elsewhere. It's a tight-rope walk every month, and she often wonders if there's a way to part-prepay her home loan. That, she thinks, might bring down her EMI and provide her tight financials a bit of breathing space. 

In her present set-up, Nigam cannot save every month and build a balance to prepay her loan, she knows. However, at the end of every financial year, some extra money – reimbursements, bonuses, etc – would get credited into her salary account. This additional money might not be huge but it would be about a month's EMI. Could she use this money to prepay her loan? And, if she could, would it make any noteworthy difference to her financials?

Let's do the maths.

A tiny step or a giant leap?

Even a humble start can prove a giant leap when it comes to battling the burden of EMIs. In fact, saving one EMI equivalent of money every year and making a lumpsum prepayment of three EMIs' worth every three years can be an effective tool for bringing down the total cost of your loan. Over time, paying extra EMIs brings down your principal amount, thereby substantially reducing your interest outgo through the loan tenure.

Suppose, you have taken a home loan of Rs 30 lakh at an interest rate of nine per cent for 20 years. You have to repay in 240 EMIs of about Rs 27,000 each – a total of Rs 64,80,000 at the start of your repayment cycle. Of this, your principal amount is only Rs 30 lakh, while you are to pay an interest of Rs 34,80,000 over the full tenure. 

If you save one additional EMI in each of the first three years, and pay a lumpsum amount of Rs 81,000 (Rs 27,000 multiplied by three), you will be able to reduce your EMI by about Rs 725 to Rs 26,375. By this time, you have paid 36 EMIs, so over the remaining 204 months, your savings would be Rs 1,47,900.

Alternatively, you could maintain your EMI at the original Rs 27,000 even after this part-prepayment and bring down your tenure by about 16 months. That translates into a saving of 27,000 x 16 = Rs 4,32,000, which is more than 14 per cent of your total principal amount. 

Subsequent savings

If you decide to follow a strict regimen even after your first reduction in EMI or tenure, and go on part-prepaying your home loan every three years, you will be making substantial savings on the cost of your home loan.