Prepay a bigger amount to reduce tenure

When a part prepayment of Rs 4 lakh did not change his equated monthly instalment (EMI), 32-year-old Rahul Mishra was taken completely by surprise. On enquiring with the bank, he was told that his tenure that had increased by a good 10 years due to repeated rate hikes, had come down to the original tenure (19 years left). "That was at least some relief," said Mishra.

Last July, Mishra took a 20-year home loan of Rs 40 lakh at 8.75 per cent. His EMI: Rs 35,348. On Wednesday, his rate stands at 10.50 per cent, up 175 basis points. As a result, his tenure has gone up by 11 years - to 30 years. Even his EMI had been hiked by the bank but only marginally up to Rs 35,883. (For the sake of simplicity it has been assumed that the rate hike took place at one go after one year in July 2011. In reality, it takes place in instalments).

After one year, Mishra's principal outstanding was Rs 39,22,770. His payment of Rs 4 lakh, 10 per cent of the original loan, reduced the principal outstanding to Rs 35,22,770, bringing down the number of years left to 19 years with a similar EMI. But most are not as lucky as Mishra.

In a rush to lessen the loan burden, many are looking at part prepaying. But, in a rising interest rate scenario, part prepaying may not make a big difference to your monthly loan outgo.

Especially if the part prepayments are small amounts. For instance, if Mishra had paid only Rs 2 lakh, his principal outstanding would have been Rs 37,22, 770. And his remaining tenure would still have been 24 years.

If you are in the initial years of a housing loan, one's monthly outgo towards home loan is used to service the interest component to a large extent. If you were to part prepay in the last few years of the loan, you would notice a big difference in your outgo as the principal amount would come down drastically.

Banks usually reduce the loan tenure each time you make a prepayment which is why your EMI remains unchanged. For a borrower constrained for cash, there is always the option of going in for a reduction in EMI, but they have to specifically ask for it. "A borrower will have to specifically ask the bank for a reduction in his/her EMI," says Vipul Patel of Home Loan Advisors, a loan consultancy.

However, reduction of EMI means that the tenure will remain high. The latter means higher interest payout in the future. Of course, what could come to the rescue is the fact that the interest rate will certainly go down over a period of 15-20 years, helping you to reduce the tenure.

The best option for borrowers stuck in high interest rate home loans is to shift their loan to a new bank. Any shift will entail costs like prepayment penalty to the old bank and processing fees to the new one and so on. Harsh Roongta of Apnapaisa.com, "If the rise in the rate is higher than the new rate and also, covers for the prepayment penalty, it may make sense to move. In this scenario, it would like 13-14 per cent." And it mostly makes sense for new borrowers to take this option.

Interest rates by banks are offered on base rate plus a spread basis. And as a new customer, you might be able to negotiate a good rate. "While old customers continue to pay higher rates, new borrowers are being given preferential treatment by banks. Most banks are reducing the spread they offer new customers, over the bank's base rate," adds Roongta.