Prepayment in loans is an important concept to understand, as it can significantly reduce your repayment burden. When you avail of a loan from a lending institution, such as a bank or an NBFC, you are tasked with repaying the loan amount within a specific duration along with interest. This interest can range from 6.5% to 20% or more, depending on the lending entity, your credit profile, and the type of loan you are applying for.
If the loan amount is insignificant, you won’t have to worry too much about the accumulating interest. For example, imagine you wish to purchase a new laptop from an online marketplace and want to finance it through a personal loan. Now, you apply for a quick loan of Rs. 1 lakh at an interest of 8% per annum. You must make regular EMI payments over the loan duration. If the tenure is 2 years, you pay an EMI of Rs. 4,523, with a total interest of Rs. 8,545 over this period.
However, when you are applying for a substantial amount—anywhere between Rs. 30 lakhs and Rs. 2 crore, you must be wary of the total interest you pay to the lender. For this purpose, you must do your due diligence and use an EMI calculator to understand the financial implications.
How loan prepayment eases the payment burden
When applying for a loan, especially one that is significant, it is crucial that you cover all the bases, read the fine print, and inquire about different aspects. One of the key considerations is the prepayment option. A prepayment is the additional amount you pay the lender besides the EMI to essentially repay a part of the loan principal. This not only reduces the amount you must repay over the loan period, but it also helps you close the loan faster.
Let us consider an example to understand prepayment better. Assume you have applied for a home loan, and the lending institution has sanctioned Rs. 80 lakhs. You have also inquired about the possibility of prepayment without any penalty fee, and you can make prepayments if needed without any additional charge. The duration to repay the home loan is 20 years, and the lender has offered the loan at an interest of 9.5% per annum.
Here is how the calculations work:
Where:
‘P’ is the loan principal
‘I’ is the monthly interest rate (annual interest/12)
‘N’ is the repayment period in months
You can use an EMI calculator to effortlessly calculate the EMI. You will have to pay Rs. 74,570 as monthly instalments. While you had taken Rs. 80 lakhs as the loan amount, the total interest that accumulates over 20 years is a staggering Rs. 98,96,919! Thus, in total, you repay Rs. 1,78,96,919 over 20 years to the lender!
How prepayment reduces this amount
Let us assume you received a substantial windfall, either as bonus or inheritance, or your salary has increased considerably after the recent appraisals. You wish to reduce the total amount you repay to the lender. Here, you can make prepayments to reduce the loan principal, which, in turn, reduces the interest you pay to the lender.
Single prepayment option (single instalment)
Let us consider the previous example and introduce a one-time lump sum prepayment of Rs. 10 lakhs. Using a loan prepayment calculator, you can get the following results:
– The EMI reduces from Rs. 74,570 to Rs. 65,162 (keeping the tenure constant). You also save around Rs. 12,48,589 on the total interest amount.
– If you wish to reduce the tenure and keep the EMI constant, you can close the loan is 173 months (nearly 15 years). Here, you save up to Rs. 40,42,948 on the total interest amount!
Partial prepayment option (multiple instalments)
Let us now assume that your recent salary hike allows you to make partial prepayments instead of a lump sum prepayment. You want to make three payments on the same date over consecutive months. In this scenario, here is the payment breakdown:
– You want to pay Rs. 3 lakhs, Rs. 3 lakhs, and Rs. 4 lakhs as partial prepayments.
– By keeping the tenure constant, you reduce the EMI from Rs. 74,570 to Rs. 65,209 and save up to Rs. 12,33,754 on the total interest amount.
– By keeping the EMI constant, you can reduce the tenure from 240 months (20 years) to 173 months (almost 15 years). You save around Rs. 40,09,240 on the total interest amount.
Using a loan prepayment calculator
Using the loan prepayment calculator is simple and intuitive. You just have to feed the following information:
– Enter the outstanding loan amount
– Input the interest rate
– Provide the remaining loan tenure
– Select the prepayment frequency
– Enter the prepayment instalment amounts
– Calculate the revised EMI and tenure
You can also calculate the outstanding principal by using the formula:
Where:
‘i’ is the annual interest rate
‘n’ is the number of times the interest is added in a year (usually, this number is taken as 12)
‘t’ is the remaining loan term (in years)
Conclusion
You can easily calculate EMIs with prepayment options by using online loan prepayment calculators. This lets you understand how much you can save on total interest by making a single or multiple partial prepayments. Before applying for the loan, you must read the fine print to see if the lender allows prepayments, and if so, if the lending institution charges a penalty fee. Knowing these specifics will allow you to make sound financial decisions.