Home loan prepayment: reduce the EMI or the tenure?

When you make a part payment, the bank usually asks one question: lower the EMI, or keep the EMI and finish sooner? On paper it looks like a small choice. In this example, one option saves more than three times as much interest as the other.

The example

A ₹30,00,000 home loan at 8.5% a year for 20 years. The EMI comes to ₹26,035, and total interest over the full term is about ₹32,48,000. Interest is charged on the balance still owed, so early EMIs are mostly interest. In the first month, ₹21,250 of the ₹26,035 goes to interest and only ₹4,785 reduces the loan.

After three years the balance is about ₹28,04,600. Now suppose you pay ₹2,00,000 extra.

All figures assume the rate stays at 8.5%. Floating rates move, so treat them as an illustration.

Why the gap is so large

Both options take the same ₹2,00,000 off the balance. Reducing the EMI then spreads a smaller loan over the same 204 months. Keeping the EMI sends every extra rupee at the balance, month after month, so the balance falls faster and the interest on it falls too. That is 29 fewer EMIs.

What each choice is good for

• Reducing the tenure gives the larger interest saving, if you can comfortably keep paying the same EMI.
• Reducing the EMI frees up ₹1,857 a month in this example. That matters if your income has dropped, or if the EMI feels too tight.

Many people pick a middle path: reduce the tenure now, and ask the lender to lower the EMI later if money gets tight. Ask your lender whether it allows that, because policies differ.

Check before you pay

• Charges. RBI rules stop lenders from charging a prepayment penalty on floating-rate home loans taken by individuals. Fixed-rate loans can carry a charge, so read your sanction letter.
• Your emergency money. Money paid into a loan is hard to get back in a hurry.
• Which option the bank applied. Some lenders apply a default. Ask for the new schedule in writing and check the months left.
• Tax effects. A shorter loan means less interest to claim. Check how that affects you with a tax adviser.

Try it with your own numbers

The formula lenders use is EMI = P x r x (1+r)^n ÷ ((1+r)^n - 1), where P is the loan amount, r is the yearly rate ÷ 12 ÷ 100, and n is the number of months. The calculator does this for you and shows what extra monthly payments save.

This guide explains how the arithmetic works. It is not financial advice. Your lender's sanction letter and current rules decide what applies to your loan.