How a loan prepayment saves interest
Home, car and personal loans in India are usually repaid with an equated monthly instalment (EMI) calculated as EMI = P × r × (1+r)n ÷ ((1+r)n − 1), where P is the principal, r the monthly rate (annual rate ÷ 12 ÷ 100) and n the number of months. In the early years most of each EMI goes towards interest, because interest is charged on the outstanding balance. Any part-payment you make goes straight to principal, so every later month is charged interest on a smaller balance. That is why a prepayment made early in the loan saves far more than the same amount paid near the end.
This calculator builds the full month-by-month repayment schedule twice – once without prepayment and once with your lump sum and/or a fixed extra amount every month – and shows the difference in total interest and tenure.
Reduce tenure or reduce EMI?
After a part-payment, most lenders let you either keep the EMI and finish the loan sooner, or keep the end date and lower the EMI. Keeping the EMI and shortening the tenure almost always saves more interest, because the higher payment keeps attacking the principal. For example, on a ₹50 lakh loan at 8.5% for 20 years, a ₹5 lakh prepayment after 12 months cuts the tenure to about 16 years and saves roughly ₹16 lakh of interest in this model, while reducing the EMI instead saves about ₹5 lakh. Choose a lower EMI only if you need monthly breathing room.
Things to check before prepaying
- Charges: under RBI rules, banks and NBFCs should not levy foreclosure or prepayment charges on floating-rate term loans to individuals for non-business purposes. Fixed-rate loans and business loans may carry a fee – check your loan agreement.
- Tax benefit: in the old tax regime, home loan interest on a self-occupied house is deductible up to ₹2 lakh a year and principal counts under section 80C. Prepaying reduces future interest, so the deduction also shrinks; in the new regime this deduction is not available for a self-occupied house.
- Emergency fund first: keep several months of expenses in liquid savings before prepaying.
- Compare returns: prepaying a loan at 8.5% is a guaranteed 8.5% saving; investing may earn more or less, with risk.
Assumptions
Interest is calculated monthly on the reducing balance at a constant rate; the lump sum is applied right after the EMI of the month you enter. Real loans can differ due to rate resets, the day-count method and lender rounding. Ask your lender for an updated schedule after any part-payment.
For information only – not financial advice. A free tool from Cute Home Pet World.
Frequently asked questions
Is it better to reduce EMI or tenure after prepayment?
Reducing tenure while keeping the EMI usually saves much more interest. Reduce the EMI only if you need lower monthly outgo.
Do banks charge for home loan prepayment?
RBI rules say floating-rate loans to individuals for non-business purposes should carry no prepayment or foreclosure charge. Fixed-rate loans may have a fee.
When is the best time to prepay a loan?
As early as possible, because interest in the early years is highest and every rupee of principal repaid stops earning interest for the lender.
Should I prepay or invest?
Prepaying gives a guaranteed saving equal to the loan rate. Keep an emergency fund first and compare with the after-tax return you expect from investing.
How is EMI calculated?
EMI = P × r × (1+r)^n ÷ ((1+r)^n − 1), with r the monthly interest rate and n the number of months.