What Happens If You Prepay a Loan?
By Pradipta Ray · Published
A prepayment goes straight to the principal, which removes every future month of interest that principal would have generated. The saving is usually much larger than people expect, and the timing matters more than the amount.
On a reducing-balance loan, interest is charged on what you still owe. Pay a lump sum against the principal and you are not just clearing part of the debt - you are cancelling all the interest that part would have accrued over every remaining month.
What two lakh does to a twenty-lakh balance
Take an outstanding balance of twenty lakh at 9%, with an EMI of twenty-five thousand, and a two-lakh prepayment made today.
| Without prepaying | After prepaying | |
|---|---|---|
| Time to clear | 10 years 3 months | 8 years 8 months |
| Interest paid | ₹10,65,764 | ₹7,98,130 |
| Interest saved | - | ₹2,67,633 |
| Or: keep the tenure, new EMI | ₹25,000 | ₹22,802 |
The interest saved is considerably more than the amount prepaid would have earned in most savings products, which is what makes prepayment attractive on a mid-rate loan.
Cut the tenure or cut the EMI?
After a prepayment, lenders will usually let you choose. The choice is not close on cost:
Keep the EMI, shorten the tenure. The balance falls faster and you save the most interest. Your monthly outgo does not change.
Keep the tenure, lower the EMI. You free up monthly cash flow, but the balance runs for just as long, so the interest saving is much smaller.
Unless the current EMI is straining your budget, keeping it and shortening the tenure is the better value. The table above shows both outcomes for the same prepayment.
Timing beats size
The same lump sum saves dramatically more in year two than in year twelve, because interest is charged on the outstanding balance and that balance is highest early on. If you are choosing between prepaying a smaller amount now and a larger amount in several years, now usually wins.
This is the mirror image of why early EMIs are mostly interest. Prepaying early removes the months where the balance - and therefore the interest - is at its peak.
What it can cost you
Check three things before transferring anything:
Prepayment charges. For floating-rate home loans taken by individuals, lenders in India generally cannot levy a foreclosure charge. Fixed-rate loans, personal loans and business loans often do. Ask for the exact figure and subtract it from the saving.
Lock-in periods. Some personal loans do not allow prepayment until a set number of EMIs have been paid.
Tax deductions. If you are claiming a deduction on the interest, prepaying reduces the interest and therefore the deduction. It rarely outweighs the saving, but it changes the maths. Check the current rules or ask a tax professional.
Prepay, or invest instead?
Prepaying a loan is a guaranteed, risk-free return equal to the loan's interest rate. An investment has to beat that rate, after tax, with certainty, to be the better choice - and very few do on a risk-adjusted basis when the loan rate is in double digits.
The other side of it: money paid into a loan is hard to get back out. Keep an emergency fund intact before prepaying anything.
Frequently asked questions
Should I reduce the tenure or the EMI after prepaying?
Will my bank charge me for prepaying?
When is the best time to prepay?
Is prepaying better than investing the money?
Calculators for this
Related reading
- How Is EMI Calculated?How Indian lenders work out your monthly instalment, why the interest portion shrinks every month, and what actually changes the number.
- How Much Loan Can You Get on Your Salary?How lenders turn your income into a loan amount, what FOIR means, and what else they check before sanctioning anything.
- Reducing Balance vs Flat RateWhy a flat 10% and a reducing-balance 10% are not the same loan, how much more the flat structure costs, and where you meet it in India.
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