Prepaying a Loan: Cut the Tenure or the EMI?

Many borrowers receive a bonus or windfall and wonder whether to prepay part of their home loan. If they do, banks usually offer two options: reduce the tenure and keep the EMI the same, or reduce the EMI and keep the tenure the same.

An example

Suppose you took a 30 lakh rupee home loan at 9 percent for 20 years. The EMI is about 26,990 rupees. After one year, you still owe about 29.4 lakh. You prepay 2 lakh rupees, reducing the balance to about 27.4 lakh.

Option A: reduce the tenure, keep the EMI

• The remaining loan is repaid in about 192 months instead of 228.
• You finish about 3 years earlier.
• Total payments fall by roughly 9.6 lakh rupees.

Option B: reduce the EMI, keep the tenure

• The EMI falls to about 25,160 rupees, about 1,830 rupees less.
• Total payments fall by roughly 4.2 lakh rupees.

Reducing the tenure saves more than twice as much.

Why tenure reduction saves more

Keeping the higher EMI means more of each payment goes to principal, so the balance falls faster and less interest accumulates.

When EMI reduction makes sense

• If your cash flow is tight and a lower EMI reduces stress.
• If you want flexibility to invest the difference.

Prepay or invest?

Prepaying a 9 percent loan gives a guaranteed “return” of 9 percent, the interest you avoid. Investing might earn more but with risk. Consider:

• Your emergency fund first.
• Tax benefits on home loan interest under the old tax regime.
• Your comfort with debt.

Charges

In India, the RBI does not allow banks to charge prepayment penalties on floating-rate home loans to individual borrowers. Fixed-rate loans may carry charges.