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Home Loan Rate Hiked? How Much Prepayment should you make to Keep EMI and Tenor Same?

Home loan rate hike? You can prepay to keep EMI and tenor same. This post shows how.

Home Loan Rate Hiked? How Much Prepayment should you make to Keep EMI and Tenor Same?


Posted on 29 Oct 2023
Author: Sayan Sircar
10 mins read
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Home loan rate hike? You can prepay to keep EMI and tenor same. This post shows how.

Home Loan Rate Hiked? How Much Prepayment should you make to Keep EMI and Tenor Same?

This article is a part of our detailed article series on the concept of home loans. Ensure you have read the other parts here:

📚 Topics covered:

How a home loan works?

Mortgage payment vs home equity

The bank gives a home loan to own the property while you use it until you pay back the loan via EMIs. An Equated Monthly Instalment plan (EMI) is a standard way to pay off a loan by making a fixed payment monthly that has both interest and principal in the same amount.

EMI = Principal + Interest

In each EMI, the split of the interest and principal changes since the interest is based on the outstanding loan balance at that point and the rest of the EMI is principal. As the chart shows, the interest part drops off with time, and the rest is the principal. The actual numbers in the chart relate to a ₹50 lakhs home loan taken at 8% for 25 years. The EMI is ₹38,591. The down payment amount is ₹12.5 lakhs.

You can test the numbers using this calculator:

As you pay back the loan, your ownership share in the house will increase in the same way. At the point of taking the loan, you own 20% of the house (12.5 out of 62.5 of which 50 is the loan). The bank owns 80%. As the loan is repaid, you own more and more of the house as the principal is paid off. This is the concept of building equity in an asset. Equity is the part of the asset you own after subtracting the part that the bank owns.

Home equity value = Current home value - Outstanding loan balance

Once you build equity in your home, that has additional benefits:

  • you can take a top-up loan in case you need money for some other purpose like home improvement, or any other reason
  • the more you will get to keep if you sell the house

We break down the home loan rate into its major components to see where the fluctuations come from.

Repo linked Home loan rate = Repo Rate + Spread + Premium

Repo rate: This rate is decided by RBI. Home loan rates will move up and down as soon as RBI revises the Repo rate

The latest repo rate is 6.5%. This rate was last reviewed by RBI on 08 Feb 2024.

Spread: This is an additional rate on top of the repo rate that essentially captures the profit the bank can make off this loan relative to the deposits it offers to customers. This rate is generally revised every three years but will vary from bank to bank.

Premium: an extra value for some specific customers. E.g SBI adds another 15bps for non-salaried customers or will depend on the CIBIL score of the borrower. This value is also revised periodically like every three years.

Related:
This article explains how overall repo rate changes affect both borrowers and depositors.

This article shows you what to do if you wish to prepay your home loan so that your EMI and loan tenure remains same after a recent interest rate hike.

One worked out example

If you are using Excel to calculate your home loan EMI, the formula to use is:

EMI = PMT(rate/12,time * 12,-principal,0,0)) where time = years left to pay the loan

Loan balance = PV(Rate / 12, time * 12,-EMI)

Metric Value
Loan balance (₹ lakhs) 50
Rate of interest 8.0%
Projected increase 1.50%
New rate of interest 9.5%
EMI 47,783
Years left 15
Prepaid amount (₹ lakhs) 4.24
New loan balance (₹ lakhs) 45.76
Prepayment % 8.482%

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How much home loan should you prepay to keep your EMI and tenor constant?

We will now show some calculations based on the amount of interest rate change applicable to you.

Percentage Home Loan Outstanding Balance to be prepaid to reduce interest rate by 0.25%

Percentage Home Loan Outstanding Balance to be prepaid to reduce interest rate by 0.25%

Percentage Home Loan Outstanding Balance to be prepaid to reduce interest rate by 0.5%

Percentage Home Loan Outstanding Balance to be prepaid to reduce interest rate by 0.5%

Percentage Home Loan Outstanding Balance to be prepaid to reduce interest rate by 0.75%

Percentage Home Loan Outstanding Balance to be prepaid to reduce interest rate by 0.75%

Percentage Home Loan Outstanding Balance to be prepaid to reduce interest rate by 1%

Percentage Home Loan Outstanding Balance to be prepaid to reduce interest rate by 1%

What if the desired reduction is more than 1%?

We can chain the payments. If you wish to reduce your interest rate by 1.5% say, you need the values from the 1% and 0.5% table and calculate the total reduction like this:

  • Loan balance: ₹40 lakhs
  • Loan duration: 15 years
  • Rate: 8%
  • Prepayment for 1% reduction: 5.78% i.e. 40 * 5.78% = ₹2.312 lakhs, balance left ₹37.688 lakhs
  • Prepayment for 0.5% reduction: 2.95% i.e. ₹37.688 * 2.95% = ₹1.112 lakhs
  • Total prepayment = ₹2.312 lakhs + ₹1.112 lakhs

The general rule is:

Total prepayment = Principal * (1- PPT_1 %) * (PPT_2 %) for two prepayments

Total prepayment = Principal * (1- PPT_1 %) * (1- PPT_2 %) * (PPT_3 %) for three prepayments etc

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This post titled Home Loan Rate Hiked? How Much Prepayment should you make to Keep EMI and Tenor Same? first appeared on 29 Oct 2023 at https://arthgyaan.com


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