How to own your dream home in half the time

Mortgages, commonly known as home loan in India, are a big burden on borrowers' shoulders. They normally consume half of your life span and take away most of your hard earned income.

The way mortages/home loan EMIs work is that you are charged the maximum interest + minimum principal in the early days of your loan. The interest portion decreases over time along with increasing prinicpal.

There is nothing wrong in this technically. The concept is like this:

If you take a home loan for Rs 20 lakh for 300 months (25 years) @10% per annum, your EMI would come out to be approximately Rs 18,000 per month.

Now, the interest is calculated on the outstanding principal. So, at the start of the loan, total of Rs 20 lakh is outstanding. Hence the interest component of first EMI is calculated as:

(20,00,000 * 10 )/ (100 * 12) = Rs 16,666

So, your first EMI of Rs 18,000 contains Rs 16,666 towards interest and rest Rs 1,334 towards your principal repayment.

So, next month the outstanding principal would be:

20,00,000 - 1,334 = Rs 19,98,666

Since, the principal amount will reduce with each EMI payment, the interest portion is recalculated every month and reduces with each EMI.

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Courtesy: Am22Tech.com

How to reduce the home loan term

The way to own your home in half the time is to make accelerated payments towards principal, that is, pay an extra amount each month over and above the EMI amount.

You may argue that it makes more sense to put the extra cash in other investments than making extra payments towards home loan. I would say you are right if that investment gives you more returns than the interest you are paying to bank.

Also, can you deny the fact that elimination of home loan from your shoulders offers tremendous psychological boost as compared to making investments?

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Concrete benefits of prepayments

Taking the same example of Rs 20 lakh again, here is the comparison:

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What are the options available to reduce the loan time

There are many ways that you can achieve this:

Refinance your home loan for a shorter term: This is a viable option if you can negoatiate a deal with another bank. Please note that another bank may charge you a higher rate of interest than existing one to increase your EMI eligibilty. Read here on how banks usually calculate income for salaried people.

Pay an extra small amount each month towards principal repayment: This is the method that I would recommend you to follow. If you see the above example, simply paying out an extra 5000 (approximately) every month reduces your loan exactly by half along with paying less interest to bank.

Paying Rs 5,000 per month extra constitutes about 28% of orginal EMI of Rs 18,000. I know that it is difficult to fetch this amount from your monthly income, but if you can stretch yourself a bit on your budget and reduce some unnecessary expenses, you can achieve a huge long term benefit.

Some financial advisors also recommend to break your PPF and fixed deposits to prepay the loans in case the interest on PPF or fixed deposit is less than home loan interest rate.

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The advantages of this method are:

It's easy for us to back out. If we decide our money is better used elsewhere, we can simply stop making extra principal payments.

Every time we make a payment, we're essentially making two payments, cutting the term of our loan in half.

Drawbacks

Some banks do charge a prepayment fees for making extra payments over and above EMI. Obviously you are hurting their income source! Most private banks have the policy to demotivate extra payment but if you have taken the loan from a government sector bank like SBI, PNB etc., you can certainly enjoy this benefit without any extra cost worries.

The policies of private and government banks differ on lot of points and you should keep them in mind while taking the loan.

The trick is simple and most of you might already know about it but have you ever applied it? If not, then be smart and start doing it now.