How adding one extra EMI to your housing loan can help you save 3.5 years | Personal Finance

On average, a housing loan is taken for 20 years. If the tenure were any shorter, say 10 years, the EMIs would be dangerously high, making it unaffordable for many.

For a ₹1 crore housing loan at a 10 per cent interest rate, a 20-year tenure results in a monthly EMI of ₹96,502, but reducing the tenure to 10 years increases the EMI to ₹1,32,151 per month. This increase in EMI is sure to derail many people's budgets, so the natural choice is to extend the tenure.

When you opt for a higher tenure, the monthly outgo would reduce, but the interest repayments would increase. For example, a 1 crore loan with a 10-year tenure at 10 per cent interest has a net interest outgo of 58.58 lakhs, compared to ₹1.32 crore over 20 years.

This puts you in a dilemma: whether to opt for a lower interest outgo by shortening the tenure or to reduce the monthly instalment by increasing the tenure.

Today, we are going to find a mathematical solution to this problem.

It is the right time to introduce the meaning of the word Amortisation. It is basically a table that shows you the monthly instalments, with their interest and principal components broken down.

For a 20-year tenure, the monthly EMI schedule would list 240 payments, but for simplicity, I have shown only the first 36.

The main thing you would notice from this chart is the interest repayment part (red column). In the initial months, the bulk of your EMI goes toward interest; i.e., 86 per cent of your EMI goes to interest, while 14 per cent goes to principal repayment.

When the bulk of your EMI goes toward interest, the principal repayment remains negligible. For illustration, in the first 3 years, your principal repayment would be only ₹5.5 lakh on a ₹1 crore loan, i.e., just 5.5 per cent.

This problem is also the first step to engineering the solution. Any additional repayments you make go entirely toward the principal, which considerably reduces the total tenure.

So, even if you start with a 20-year tenure, you can figure out a way to pre-close the same in 12 to 15 years.

A 20-year loan can be paid off in 16 years and 3 months if you opt to pay one additional EMI each year. If you pay 2 EMIs extra per year, you can close it in 13 years and 11 months.

If you pay 3 EMIs extra per year, the tenure is revised to 12 years (assuming an interest rate of 10 per cent).

Each additional instalment you make toward the principal reduces your interest burden proportionately.

Note: Although this calculator intuitively shows the revised tenure, the actual calculation may differ if the prepayment is made in any month other than the last. The earlier you prepay, the faster your loan closes.

The writer is a SEBI Registered Investment Adviser (INA000021757), SEBI Registered Research Analyst (INH000025045), and author of ‘How to join the top 1% options traders club’.

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