Paying home loan EMI’s month-after-month is a burden. How to reduce home loan EMI? By making loan ‘prepayment‘. What is prepayment?
It is an extra payment made to ones home loan account in addition to the EMI. How prepayment helps? It reduces the loan outstanding faster.
But while one is making the prepayment, bank will ask the borrower, shall the prepayment be utilised to reduce EMI or tenure? What one must do? Which option is better?
This is what we will discuss in this article.
When I was making my first home loan prepayment, this question struck me unprepared. Anybody who has made a prepayment of their home loan, must have faced the same question.
Banks compulsorily asks this question to the account holder while receiving the prepayment amount. The problem is, most of us are not prepared for the answer. As a result, banks reduces the tenure by default.
There is no doubt that prepayment amount used for ‘tenure reduction’ is more profitable. But this doesn’t make EMI reduction obsolete. EMI reduction is also as effective.
I have written a separate blog post on prepayment of loan for tenure reduction and its advantages – check the link. I would utilise this space to talk more about prepayment for “EMI reduction”.
Why to Reduce Home Loan EMI?
People dream about buying a big home for self. But the limitation is obvious. Bigger house will cost more, and higher is the cost, more will be the EMI.
The problem with EMI is that, it’s a recurring expense. No matter what may come, the EMI will be debited from ones account on a fixed date of every month.
EMI’s are like an expense set on auto-mode. Hence, its long term psychological effect on the payee (a common man) is not positive.
It’s intensity becomes even more magnified when EMI is very high. Hence, it is in our interest to make loan prepayments and reduce the EMI burden.
What means by EMI reduction and tenure reduction?
Let’s understand this with an example. Suppose one took a home loan of Rs.65 Lakhs, @9% p.a. for 20 years. In this case the EMI will be Rs.56,409 for next 20 years. Total payment of Rs.1,35,38,042 – Interest plus principal.
This person decides to make a prepayment of Rs.1,14,000 in the 13th month. Now, he has two options:
- Reduce EMI: The person is currently paying an EMI of Rs.56,409. Upon prepayment of Rs.1,14,000 in 13th month, the benefits will be these:
- In Short Term: The estimated EMI reduction will be from Rs.56,409 to Rs.55,399 (Saving of Rs.1,010 each month).
- In Long Term: Over a period of time, due to reduced EMI, the person will pay only Rs.1,34,21,897. Which is a saving of Rs.1,16,145 (13538042 – 13421987).
- Reduce Tenure: Loan tenure on the first month was 240 months. What does it mean? Means the person will have to pay EMI’s for 240 months to pay it off. Upon prepayment of Rs.1.14 Lakhs in 13th month, the benefits are these:
- In Short Term: There will be no benefits, why? Because the loan EMI will remain the same at Rs.56,409 (Saving is Rs.0).
- In Long Term: Here there will be two benefits. First, the loan will be paid off in 231st month itself. Second, the person will pay only Rs.1,31,03,435. Which is a saving of Rs.4,34,608 (13538042 – 13103435).
So, tenure reduction is better than EMI reduction? On face of it, it looks like this. But a more detailed analysis will give alternative conclusion, why? Because type of savings made from EMI and tenure reduction are different. Lets know more…
Difference in type of savings
There is a distinction between the savings shown in the above table:
- In case of EMI reduction: Savings starts to happen immediately. From the next month itself, the borrowers starts to pay less EMI’s (Rs.1,010 less), till end of tenure – in 20th year. Read more about why to become debt free?
- In case of tenure reduction: Savings will be realised only when the tenure ends, why? Because the borrower will continue to pay the same EMI till the end of tenure. When the tenure ends (in 230th month instead of 240th), it is only then the benefit of the prepayment will be realised. Read about smart ways to become loan free.
Present Value of Future Savings
To fairly compare the benefits of EMI and Tenure reduction, we must use the concept of “present value“. Read more about the present value concept.
In our above example, the borrower has made a prepayment of Rs.1,14,000 in the 13th month, and eventually the money was saved. A representation of savings schedule has been shown below:
How to calculate the present value of all these future savings? By using Present Value formula of Excel [Present Value = PV(rate, nper, pmt, [fv])]. Read more about investment answers using excel.
- EMI Reduction: In our example, present value of all savings will be Rs.1,36,888 (= PV (6%/12, 227, 1010, 0).
- rate: discount rate = inflation = 0.5% p.a. (=6%/12) – [** 6% assumed inflation for next 19 years. 6%/12 = inflation per month.]
- nper: total number of savings months = 227nos (=240 – 13).
- pmt: savings in Rs. per nper = Rs.1,010.
- fv = Lump-sum saving at end = Rs.0.
- Present Value = Rs.1,36,888.
- Tenure Reduction: In our example present value of all savings will be Rs.1,51,524 ( = PV (6%, 18.08, 0, 434608)).
- rate: discount rate = inflation = 6% p.a.
- nper: total number of savings years = 18.08 [=(230 – 13)/12].
- pmt: savings in Rs. per nper = Rs.0.
- fv = Lump-sum saving at end = Rs.4,34,608.
- Present Value = Rs.1,51,524.
[P.Note: The ‘quantum of savings’ estimated by present value method will be different from one shown in above flow chart].
What we can conclude?
|Description||EMI Reduction||Tenure Reduction|
|Overall Savings (Rs.)||1,16,154||4,34,608|
|Present Value of all |
If we’ll see only superficially, as shown in the above flow chart, it looks like ‘tenure reduction’ is far more rewarding than ‘EMI reduction’. But when we see it through the prism of “present value”, the difference is not much. Hence, I would like to conclude it like this:
- At Par: On computing present value of all future savings envisaged after prepayment, EMI reduction and Tenure reduction is almost at par. But still, tenure reduction is slightly more profitable. Read more about tips and tricks to save money.
- Role of Banks: Banks will not tell us that tenure & EMI reduction are almost similar. They would like us to believe that tenure reduction is better, why? Because if EMI is high, banks collect more each month. Moreover, in this case the loan also gets over faster (hence less risk for banks). Read more about debt traps.
- Use saved EMI: If the difference is so small, as a borrower, I would rather reduce the EMI upon prepayment, why? Because the money saved on EMI, can be reused to make more prepayment in future. Also, I can invest the saved EMI in (say) a mutual funds for fast capital growth. Check this SIP return calculator.
I’ve prepared two excel based prepayment calculators. One calculator is to check potential savings from EMI reduction, and other is for tenure reduction.
You can check my blog post on how to use my excel based prepayment calculator (for EMI reduction).
Hey Mani. Let me try an alternate way of analysis. First of all great work. 🙂 Appreciate the efforts on the blog. Now on the scenario of EMI reduction, the effective savings per month is INR 1,010. Instead of bringing it to PV, I would rather look at the FV. Assume we are able to reinvest the INR 1,010 every month to index mutual fund (safe side) for 231 months (same as when we get the tenure reduction benefit). On a decent assumption of 12% per year CAGR, the amount stands at staggering INR 7,73,094. The benefit of tenure reduction on the same day is INR 434,608. Hands down the reduction in EMI is able to beat the tenure option. Thoughts? I think the difference between your assumption and mine was you taking the inflation rate and me taking an investment CAGR.
Hi Amit, equity investing will fetch higher returns. So you have a point.
But the purpose of this article is debt management, not investing.
To manage debt, immediate pre-payment of a loan is the best alternative.
Thanks for posting your views.
Keep reading. Cheers.
awesome blog helpful for many people.
Mani, i have. personal loan of 15 lakhs paying 32000 per month for 5 years. Now I am able to make an additional monthly payment of 50k. So do you think tenure reduction will be better of in effect is there any difference of the amount of interest we pay between emi reduction vs tenure reduction. thanks
I’m not sure if I’ve understood your point clearly. Generally speaking, tenure reduction will save more than EMI reduction.
I have taken loan of around 18 lacs for 20 years and emi around 14500 /-. Actualy rent comes from my Property around 18000 Rent comes. So, I am capable to pay EMI and also prepayment of Loan. I want to pay Loan around 5 years. What is the best way to pay less interest Reduce EMI or reduce tenure.
If you want to save on interest, go for the tenure reduction. Thanks for asking.
Awesome analysis. Being my self Civil Engineer. I could related the kind of detailed insight & proper flow diagram & crisp analysis with less technical jargons. Very rarely see the analysis in all the aspects. Keep up the good work Mani sir.
I got PMAY subsidy of INR 2.35 Lakhs and asked bank to reduce EMI so I can save monthly amount around 1.5-2k , that can be used in forthcoming years to do partial repayment to home loan outstanding amount and reduce home loan tenure.
Bank told me that EMI reduction will be chargeable as loan account will get modification, It will charge you and also affect the CIBIL score. They have suggested me to reduce tenure rather than EMI reduction based on PMAY. My concern here does Home loan EMI reduction is chargeable? and My strategy is to reduce EMI based on PMAY subsidy and use those save money to do partial payments and reduce tenure which ends my loan faster..does it sounds good?
The only blog I read on this topic which gives you a complete analysis. All the other blog simply shows the interest saving while opting for reduced tenure. I’m a big advocate of reducing the EMI if 1) The person can invest the difference in mutual funds or 2) EMI is becoming too difficult to manage and the reduced amount will give a breather. Amazing work Manish sir, keep it up.
Thank you for posting your views.
Thank you for the details insight. I have a specific query related to my SBI home loan. I have moved my home loan from hdfc to sbi recently, and my home loan description is showing as “MC-HL-SAL 30L81 APR 19”. Can you please tell me that what type of loan product they have given to me. Is it regular SBI home loan or max gain? Can you get the idea by looking at the description above. I have one more query –
I have taken the loan of Rs. 26 lacs with 8.6 ROI for 20 years by default. My EMI is set to Rs. 23225 per month currently. However I can pay extra approx 12-14K more per month. Which is better option – increase EMI or pre-payment via bank transfer each month ? Or do you have any other better option? I wish to conclude my home loan asap in max 10 years or lesser.
If you are comfortable, increasing monthly EMI is the best option. It will close the loan faster.
I have gone through your blogs, narrative is very good & useful. Thanks for the good postings which is very helpful.
I have a one query. I am NRI, I have Home loan in Axis Bank. Loan amount is 45 Lakhs for tenure of 164 months @ 8.85% current interest rate ,Paid 36 months, Current outstanding is 38 Lakhs.Planning for prepayment of lumpsum amount around 17 Lakhs.
Suggest me whether to reduce tenure or EMI as I am dilemma, my idea is to clear the loan as soon as possible within couple of years.
If objective is to clear the loan, tenure reduction is a better option. Thanks for asking.
These days banks simply allow prepayment as a simple bank transfer into loan account, and it automatically gets translated to tenure reduction. Banks dont ask the question of EMI reduction.
But given an option tenure reduction is better because EMI reduction means interest outflow will still be higher and it sort of nullifies the gains made by prepayment. Anyway if current EMI is affordable then no need to reduce it.
Thank you, for brief explanation about the saving.
I have taken loan of 3200000 for 12 years and paid for 2 years. Currently balance shows as 2900000.
SBI – MAXGAIN is current plan.
Now I am planning to change Tenure to reduce.
Does New EMI will be calculated on Original amount or Currently balance?
The revised calculation will be done on current loan outstanding.
You can also read about reducing balance method of interest calculation. It will give you an idea of how interest is calculated on current balance.
Thanks for asking your query.
Thanks for the detailed information.
Person X has a similar scenario which was asked before but with small differences.
Please consider the below scenario:
E.g. current EMI is 24000 with 9.2% interest rate and tenure as 15 yrs.
Person X is having savings every month for e.g. 50-60K which he uses for repayment and subsequently tenure gets reduced.
Do you think going for lower EMI will help the person as it’ll enable him to make higher repayment every month?
Awaiting for your reply !!
Going for tenure reduction will always fetch higher savings. The benefits will be similar if the reduced EMI amount is used as “additional-prepayments”. But practically, this process may not continue for long time (think about it). Hence, better is to follow a hassle free approach – prepay for tenure reduction. Thanks for asking.
Thanks for your valuable input. Really appreciate it !!
What happens if I reduce EMI and make Prepayment(Principal) more for home loan?
or Increase EMI with no prepayment? Which option saves more money during 1st year?
Ex: EMI 35,300, for a 10 year loan. Decreasing EMI 20,000 and make prepayment with the saved money?
or increasing EMI to 40,000 and no pre payment?
Which saves me more money?
Thanks for the awesome query. Superb.
First make prepayment and reduce the EMI. This monthly savings in EMI is then accumulated. One the accumulated saving becomes big enough, make a lump-sum prepayment again. No doubt this will also save money, but there are too many steps involved here.
1) If I had extra lump-sum savings, I will use it to make a lump-sum prepayment and reduce the tenure. This will save maximum.
2) If I do not have extra lump-sum savings, I will increase EMI (from say Rs.35K to Rs.40K). This will also save money but as as much as 1 above.
Firstly Thanks for your detailed article in this blog.
secondly Thanks for your immediate response.
I was thinking to increase EMI from 35k to 40k. during which i thought to keep 35k constant and prepay the accumulated savings. but confused about the math involved there.
Your response concludes to me: I do not have lump-sum at the moment. No need to think keeping EMI constant(35K) wait for accumulating savings for nearest months. so i go with 40k now. correct me if iam wrong.
Thanks once again.
Your thinking is right.
In the case of tenure reduction, why is that you do not consider the EMIs saved as part of the reduced tenure as having potentially invested into a SIP and generating some additional profit as well?
BTW, 15% of consistent return from sip will be an interesting proposition, that challenge the whole idea of buying a house… How does this stack up against the idea of living rented for 20 yrs and just invest the delta in SIPs during that time
Idea is good, but trick lies in its effective implementation. Thanks for your comments.