So, you have some extra money sitting in your account and are wondering whether to use it to prepay your home loan? Or should you invest it?

While the obvious answer would be “Pay off the loan and reduce your debt!”, the actual answer is a tad bit more complicated.

A home loan is usually one of the cheaper forms of borrowing. So, before you rush to pay off that home loan, you need to look at the bigger picture. 

Sometimes, prepaying makes perfect sense. Sometimes, investing your surplus makes more sense. And sometimes, the smartest way is to do a little of both.

The only question is: how do you know what path to follow?

What Is Home Loan Prepayment?

To put it simply, a home loan prepayment is paying more than your EMI towards the repayment of your loan before the end of the loan tenure.

This can be done in two ways:

• A part prepayment, in which you pay a lump sum amount towards your outstanding principal.
• A full repayment, in which you pay the entire outstanding balance and close the loan.

Now, logic would say that reducing the principal amount automatically reduces the amount on which future interest is calculated. But let’s understand how much difference this can make in the long term.

How Does Home Loan Prepayment Save Interest?

When you take a loan, you may think that the EMI you pay every month goes towards reducing your principal amount + the interest accrued. But, especially in the early years, a large portion of your EMI typically goes towards the interest.

So, when you make a part prepayment, you’re not just reducing your total loan balance, you are also reducing the principal on which future interest is charged.

So, when you make a part-prepayment, you’re not just reducing your loan balance. You’re also reducing the principal on which future interest will be charged.

Let’s assume you have ₹40 lakh outstanding on your home loan at 8.65% p.a., with 10 years left on the tenure. If you continue as is, you will end up paying about ₹20.13 lakh in just interest over the next 10 years. 

Now, say you prepay about ₹10 lakh. Your outstanding balance is now ₹30 lakh. If you stick to the same 10 year tenure, your total interest to be paid will reduce to approximately ₹15.10 lakh.

That is a potential saving of about ₹5.03 lakh on a ₹10 lakh prepayment!*

*Your actual savings will depend on your loan terms, and whether you choose to reduce your EMI or loan tenure after making the prepayment.

Should You Prepay Your Home Loan or Invest?

Now, this is where things get interesting.

A home loan is not necessarily a debt that you need to get rid of immediately.

If your home loan has a relatively low interest rate, you should consider whether the surplus amount could be put to better use elsewhere. For example, that money could be invested, saved as a financial cushion, or even used toward another financial goal.

Let’s assume your home loan costs between 8% and 9%, and you have an investment opportunity that could generate higher returns. Investing even some of that extra money could help create more wealth rather than using it all to prepay the loan.

But there is an important point to remember: investment returns are not guaranteed. The interest you save through prepayment is more predictable.

So, don’t just compare the two numbers and pick the number that looks higher. Consider your risk appetite, liquidity needs, financial goals, investment horizon, and tax implications too.

What Are the Benefits of Home Loan Prepayment?

Prepaying your home loan makes sense if you want to reduce your debt and interest outflow.

It can help:

• Pay less interest over the remaining loan tenure
• Reduce your loan tenure if you continue with a similar EMI
• Lower your EMI, depending on your lender’s terms
• Become debt-free sooner
• Reduce your overall financial burden

But there is another side to the equation.

The money you use to prepay is money you no longer have available for something else.

And that’s worth thinking about.

When Should You Not Prepay Your Home Loan?

Let’s be honest: being debt-free sounds like an amazing concept. But it is not that great if it leaves you with no financial breathing room.

Before you pay a large amount towards your home loan, ask yourself the following questions:

Do I have enough money in my emergency fund?

If an unexpectedly large expense comes up in the next 6 months, would you be able to tide through without needing to borrow?

Do I have debt that is more expensive?

If you have a high-interest personal loan or a credit card debt, it makes more financial sense to pay that back first.

Do I have other important financial goals or milestones coming up?

Retirement coming up? Need to pay that huge fee for your child’s education? Have a major purchase lined up? Save your surplus for those expenses.

The goal isn’t simply to have zero debt. It’s to have a financial plan that works.

Should You Reduce Your EMI or Loan Tenure After Prepayment?

Once you make a part prepayment, you may have two choices based on your lender’s terms: either reducing your loan tenure or reducing your EMI.

If you want more money available every month, reduce your EMI.

If you are comfortable with your current EMI and want to maximise your savings, reduce your tenure.

Think of it this way:

Lower EMI = more breathing room now.

Shorter tenure = potentially more interest saved and an earlier finish line.

The better option depends on what your finances need right now.

What Should You Check Before Prepaying?

Before you decide to prepay your loan, here are some factors to consider:

• Interest rate
• Outstanding principal
• Remaining tenure
• Current financial liquidity
• Other debts
• Financial goals
• Lender’s terms

Are There Charges for Home Loan Prepayment?

The short answer is: maybe.

This depends on various factors, such as:

• Lender
• Loan terms
• Borrower profile
• Applicable regulations

Before you make a part prepayment or close your loan, check your lender’s current terms as well as your loan agreement.

Don’t assume the terms and rules are the same for all home loans. Make sure to check applicable pre-payment charges, minimum payment requirements, or other conditions that may apply to your loan.

When Is the Right Time to Prepay a Home Loan?

To be very honest, there is no magic number or a point in the loan tenure that is perfect.

Prepayment only makes sense when you have:

• Surplus money
• Adequate emergency savings
• Other financial priorities on track

The timing matters too. If you have a major chunk of your tenure ahead of you, reducing the principal can go a long way in reducing the amount of interest you pay. 

But don’t prepay simply because you had a windfall. First ask yourself what that money needs to do for you.

So, Should You Prepay Your Home Loan?

Maybe. And that’s the point.

Prepayment could prove to be a smart financial decision. But so can investing that same amount of money, creating an emergency fund, or paying off a more expensive loan.

There is no medal for you to become debt-free at the cost of everything else.

So, instead of asking yourself “how quickly can I close my home loan?”, ask yourself “what is the smartest way to use this money?”

Look at your finances as a whole and not through the lens of your debt. Then decide if you want to prepay, invest, or do a bit of both.

Make the Decision Based on the Bigger Picture

Your home loan is one part of your financial life. It shouldn’t dictate the entire plan.

Understand what your loan is costing you. Understand what your money could do elsewhere. Compare the two, consider the risks, and then make the decision that works for you.

“Prepaying a loan may reduce your interest burden, but the decision should not be made in isolation. Your liquidity, investments, and long-term financial goals all play a role in deciding where your money can create the most value.”

Vijay Kadam, Co-Founder, Finfinity