Which is financially smarter: Increasing EMI amount or prepaying the home loan?
The decision between increasing your EMI or making a lump-sum prepayment depends on your various factors like your financial priorities, income stability, interest rates and long-term goals.
Should I increase my EMI amount or prepay the home loan if I get a salary hike or an annual bonus? Which is financially smarter?
If you’ve recently received a salary hike or annual bonus, it’s a good time to reassess your home loan repayment strategy.
Here’s a breakdown of both options to help you decide which is financially smarter:
Increasing EMI Amount
Benefits:
Faster Loan Repayment: Increasing your EMI accelerates the repayment of the principal amount, reducing the loan tenure and eventually reduces the total interest paid over the tenure of the loan.
Consistent Commitment: It demonstrates financial discipline and can improve your credit score, as you are consistently making higher payments and a better loan eligibility, if need arises.
Flexibility: If your income increases regularly, you can adjust your EMI accordingly to utilise the extra funds effectively.
Drawbacks:
Higher Monthly Commitment: You need to ensure you can sustain the increased monthly payments without straining your finances.
Prepayment
Benefits:
Flexibility: Prepayment allows you to reduce your loan burden whenever you have surplus funds, such as bonuses, without committing to higher monthly payments.
Interest Savings: Prepaying reduces the outstanding principal, which in turn decreases the interest component and shortens the loan tenure.
Drawbacks:
Opportunity Cost: Tying up funds in prepayments might limit your ability to invest in other potentially high-yielding assets.
Thus, the choice between increasing your EMI and prepaying depends on your financial situation and goals:
Stable Income and Higher EMI Preference: If you have a stable income and can comfortably manage higher monthly payments, increasing your EMI is a more effective way to reduce interest costs and shorten the loan tenure.
Irregular Income or Preference for Flexibility: If your income is irregular or you prefer flexibility, prepayment is a better strategy as it allows you to reduce your loan burden without committing to higher monthly payments
When not to prepay a loan?
While prepaying is usually convenient, here are a few situations when you should definitely steer clear of paying off loans early:
– If you’re using up your emergency fund to prepay
– If the home loan rate is very low and you have other investments that can give you higher risk-adjusted returns
– If your bank levies a penalty on loan foreclosure
Here’s the bottom line: Loan prepayment isn’t a one-size-fits-all-solution. Prepayment is more of a strategy that includes analysing your savings, your ability to prepay and still have liquid funds for emergencies.
Final thoughts and recommendations:
Assess Your Budget: Determine how much extra you can comfortably pay each month. If you can afford significantly higher EMIs without straining your finances, this might be a straightforward option.
Consider Prepayment Penalties: Check your loan agreement for any penalties on prepayments. If they are minimal or non-existent, making prepayments can be a flexible way to reduce your loan burden.
Calculate the Interest Impact: Use a loan calculator to compare the total interest paid in both scenarios over the loan term. This can help you visualize the long-term savings.
Hybrid Approach: If possible, consider a combination of both strategies. You could increase your EMI slightly and consider making occasional prepayments when you have extra funds.
Ultimately, the best option depends on your financial situation, goals, and the specifics of your loan. If your priority is to finish the loan ASAP, either method will help, but choose the one that aligns best with your financial comfort and flexibility.
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