Category: Banking

Which is the best time to prepay the home loan? Is it during the first few years of the loan term? Is it wiser to invest somewhere instead of paying off the loan? Are we really saving home loan interest by prepaying? Let us try to answer these questions by taking a simple example.

Many of us have home loans and due to the recent rise in inflation and interest rates, most of the borrowers are wondering or in a dilemma whether to prepay the home loan or not.

Which is the best time to prepay the home loan?

I know many of you will already have a ready-made answer to the question whether it is valid to prepay if the loan is fresh. However, what is the opportunity cost of not paying off the home loan and investing elsewhere? Is it equal to or less than the home loan rate?

The purpose of this post is to highlight this opportunity cost. This means if instead of prepaying the home loan, you invest in lump sum, what should be your ideal break up?

Many people randomly assume that if the home loan interest rate is 8% and if they prepay the outstanding, they will save about 8% upfront interest payment on the outstanding loan principal. However, this is a complete myth.

This is mainly because in the home loan EMI, your interest portion is usually higher during the first few years, and will come down considerably later. So, when you plan to prepay the principal, how many years are left and the total interest you have to pay during the loan tenure also matters.

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For our example, assume the home loan amount is Rs. 1,00,00,000, the rate of interest is 8% and the term is 20 years. The EMI will be Rs 83,644. The total interest paid by you during the entire period of 20 years is Rs.1,00,74,561. If we combine both the principal and interest, then in total you will have to pay Rs 2,00,74,561.

To understand what is the opportunity cost of prepaying the home loan and which is less stressful, let us break down the entire tenure into each of the loan tenures of 5 years.

You see that during the first five years, you paid around 37% of the total interest (Rs 1,00,74,561) and you paid around 12% of the principal amount.

Hence the balance payable is Rs. 87,52,558 (Principal) + Rs. 63,03,362 (Interest) = Rs. 1,50,55,920.

Now let’s assume that after 5th year you have Rs 87,52,558 in your kitty and you want to repay the loan. So obviously the savings for you is the interest part of Rs 63,03,362.

What amount of Rs 87,52,558 will have to be generated in the next 15 years to compensate Rs 63,03,362? That’s about 3.7% not the 8% many people save!!

Similarly, if you want to prepay after the end of 10th year, you need to consider these numbers.

You see that by the 10th year, you paid around 69% of the total interest (Rs 1,00,74,561) and around 31% of the principal.

So the outstanding amount payable after 10th year is Rs.68,94,062 (Principal) + Rs.31,43,217 (Interest) = Rs.1,00,37,279

Now let’s assume that after 10th year you have Rs 68,94,062 in your pocket and you want to repay the loan. So clearly for you, the savings is the interest part of Rs 31,43,217.

How much will this amount of Rs 68,94,062 have to be generated in the next 10 years to offset Rs 31,43,217? This is approx 3.82% and not 8% savings like the common belief of many people!!

What if you want to prepay the loan after 15th year? Below is the status of the loan after completion of 15 years.

You see that during 11th to 15th year you paid almost 91% of the total interest (Rs 1,00,74,561) and 58% of the principal amount.

Then the balance payable will be Rs. 41,25,190 (Principal) + Rs. 8,93,448 = Rs. is 50,18,639

Now let’s assume that after 15th year you have Rs 50,18,639 in your pocket and you want to repay the loan. So clearly the savings for you is the interest part of Rs 8,93,448.

How much will this amount of Rs 50,18,639 have to be generated in the next 5 years to compensate Rs 8,93,448? This is just around 4% instead of the common perception of many as 8% savings!!

Another way to prove it is that paying off the home loan during the first few years has a far better and less stressful opportunity cost than postponing your home loan repayment to the latest tranche of the home loan.

RBI once again increased the repo rate by 0.50% on August 2022 during its bi-monthly monetary policy meeting. FD interest rates have increased further due to three consecutive repo rate hikes. FD investors can look forward to better days as the era of historically low FD rates is now unquestionably behind us. These are some of the banks which have increased the fixed deposit interest rate after the hike by RBI.

1. State Bank Of India

State Bank of India (SBI) has increased interest rates by up to 15 basis points (bps) on select fixed deposit (FD) tenures. According to the bank’s website, the new rates will be effective from August 2022 and will be applicable on FDs of less than Rs 2 crore.

With effect from August 2022, the bank has increased the FD interest rate from 180 to 210 days to 4.55%. The interest rate has been increased from 5.30 % to 5.45% for a period of one to two years. SBI has increased the interest rate on loans with terms of two to three years to 5.50%. The rate has been increased to 5.60% for three to five years. The bank will now offer 5.65 % for tenures of 5 years and up to 10 years.

2. Kotak Mahindra Bank

Kotak Mahindra Bank has increased FD interest rates by up to 15 basis points for one to three years (for amounts less than Rs 2 crore) starting August 2022.

The interest rate on FDs with a maturity of 365 to 389 days has been increased by 15 basis points to 5.75 % from 5.60 %. The interest rates on FDs with maturities ranging from 390 days to three years have been increased by 15 basis points to 5.90 % from 5.75 %. interest rates have not been raised for a period of three to ten years; They will continue to earn 5.90 %.

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3. ICICI Bank

ICICI Bank has increased interest rates for select term deposits (FD) by up to 40 basis points for amounts below Rs 2 crore. The new rates will be effective from August 2022. For regular citizens, ICICI Bank will now offer interest rates ranging from 2.75 % to 6.10 % for tenures ranging from 7 days to 10 years.

4. HDFC bank

HDFC Bank has increased fixed deposit (FD) interest rates after a gap of two months. The bank has increased the FD rates by up to 40 basis points with effect from August 2022. These rates are applicable on deposits of less than Rs 2 crore.

According to HDFC Bank’s website, from one-year to two-year tenure, there will now be an increase of 15 basis points to 5.50 % instead of 5.35 %. For a tenure of two to three years, 5.50 % of earnings will continue. The bank increased the interest rates for the three-year one-day to five-year by 40 basis points, from 5.70 % earlier to 6.10 %.

5. Axis Bank

With effect from August 2022, Axis Bank increased the FD interest rates on fixed deposits (FDs) for a limited period (for amounts less than Rs 2 crore).

The bank has increased its fixed deposit interest rate for FDs of 17 to 18 months by 45 basis points from 5.60 % to 6.05 %. The Axis Bank website states that the interest rates remain the same for other FD tenors.

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6. PNB Bank

PNB has increased the interest rates for fixed deposits (FDs) to less than Rs 2 crore. For some periods, the bank has increased fixed deposit interest rates by up to 20 basis points (bps). According to the PNB website, the new interest rates are effective from August 2022.

PNB has increased the interest rate on long-term FDs by up to 20 basis points. The bank will now offer an interest rate of 5.50 % on deposits maturing in one year, at an increase of 20 basis points. PNB has increased the interest rate on deposits maturing in more than one year and up to two years by 15 basis points (bps), raising it to 5.50% from 5.45%. The bank will continue to offer an interest rate of 5.50 % to 5.60% on deposits maturing in more than two years and up to three years.

PNB has added a new tenure of 405 days with an interest rate of 6.10 % with effect from August 19, 2022. The other tenure that has been added is from 406 days to two years with an interest rate of 5.50 %.