Most of your home loan EMI goes towards interest. Learn how small extra payments can save you lakhs and close your loan early.
If you are also paying your home loan EMI (Equated Monthly Instalment) every month without fail and your loan amount isn't reducing even after years, there's no need to worry. This is a common problem faced by many people.
In fact, there is a specific reason behind this, which is that your principal amount decreases very slowly in the initial years.
In the early years of a home loan, a very large portion of your EMI goes only towards paying the interest. Meanwhile, the principal amount reduces very little.
People often think that their loan is decreasing equally with each EMI, but that's not the case. Interest is always calculated on the outstanding loan amount, which is highest at the beginning. This is why the maximum part of the EMI in the initial months goes towards paying interest.
Suppose you have taken a loan of Rs 1 crore for 20 years at an 8 percent interest rate. In this situation, your monthly EMI will be around Rs 83,644.
You might be surprised to know that in the very first month, Rs 66,667 of this EMI will be just for interest. Only Rs 16,977 will be deposited towards your principal amount.
Speaking of this 20-year loan, the major portion of your EMI starts going towards the principal during the 10th to 13th year.
During this period, the principal component of the EMI becomes more than the interest component, and your loan starts to decrease very rapidly.
If you want to finish your loan before the scheduled time and pay less interest, there is a great way to do it. You can start depositing a small additional amount (pre-payment) every year.
Your annual bonus or incentive can be used to make a prepayment. This can help you save lakhs of rupees in interest and become debt-free ahead of time.
For example, if you deposit an extra Rs 1 lakh every year from the sixth to the tenth year (a total of Rs 5 lakh) on your Rs 1 crore loan, it directly reduces your outstanding principal.
The result will be that you will save about Rs 8.4 lakh in interest on the entire loan. Your 20-year loan will be paid off 1 year and 4 months earlier, i.e., in 18 years and 8 months.
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