Axis Bank has recently launched a new ad for their home loans, and the pitch of the ad focuses around the "pre-payment charges". The theme is that a couple wins a lot of money in one of the TV shows and they plan to prepay their home loan using the prize money. The anchor asks them about prepayment charges, which are usually levied when someone pays up a loan before his loan schedule i.e. extra money reapid early over and above the usual EMI payment amount, so as to close the loan early. These pre-payment charges are for this kind of early payment of loan. Then the prize winner hits the punchline - "Paise chukane ke bhi paise lagenge" i.e. to pay back money, you need to pay money (charges). Then her hubby says that "Dont worry, our loan is with Axis Bank who do not have any pre-payment charges".
This ad clicks (atleast to me and my fellow colleagues) - the reason? It hits right into the current economic scenario where banks are raising the interest rates every now and then and people are either required to pay higher EMI's or their loan tenures are increasing or both. What that ultimately means? Your loan amount is same, but what you repay to the bank is increasing considerably.
Home Loan PrePayment Charges Calculator
Disclosure: One of the authors has a home loan from Axis Bank which is without pre-payment charges. This article is based upon calculations done on those inputs and scenarios where interest rates have changed very frequentlyLet's start from the basics:
What are home loan prepayment charges? Why do home loan banks or NBFC take such a prepayment charge?
Home Loan Prepayment charges are those charges which have to be paid in case one decided to repay his/her home loan earlier than the agreed loan achedule. However, please note that some banks & NBFC do NOT have prepayment charges on home loans, some banks have it if the amount being prepaid exceeds a limit (say 20% of the outstanding loan amount each year), while some banks or NBFC have it mandatorily.
NBFC - Non Banking Financial Companies (These are not banks so they dont come under Reserve Bank of India regulations directly. E.g. are Indiabulls, LIC Housing Finance Company, HDFC Limited). One thing which is important to mention here is that although HDFC is known to be one of the largest home loan providers in India, the home loan division is not under HDFC Bank, but it is HDFC limited, an NBFC.
Why do banks or NBFC charge prepayment charges amount?
Because when you take loan for a specified period of time (say 25 Lakhs for 15 years at 10%), your EMI will come to 26,865 Rs. Banks know for sure that you will contine to pay this EMI amount each month for the next 15 years.
So in this case, you pay back the bank a total of 48,35,700 Rs. in total, over your tenure of 15 years (assuming no changes to interst rates).
But when you decide to prepay your home loan amount i.e. add more amount to the paid EMI, then the calculations change. Your loan tenure comes down from 15 years.
Say after 1 year of you taking home loan, you got a bonus of 2 lakhs, or you sold your old property and use that money to prepay your existing home loan. So now, because of this prepayment of 2 lakh Rs. after 1 year of you taking the home loan, your total amount paid back to the bank has come down to 43,13,050 and your tenure has also come down from 15 years to 12 years and 10 months. So, because of this prepayment, you managed to save 5,22,675 Rs. and your home loan tension period shortened by 2 years and 2 months. So this is beneficial to you.
However, for the bank, it is a problem. The amount that they were relying upon as a steady stream for 15 years has come down to a lesser amount as well as for a lesser tenure. That is something which hurts their profits, as well as cashflows. Hence, they impose a charge for such prepayments.
Related: Home Loan Tax Benefits and All Home Loan Articles
Is it beneficial for the borrower to prepay his home loan as early as possible?
In short, the answer is YES.
Remember, the longer your loan tenure, the more money you repay to the bank for the same loan amount. Continue to Part II - PrePayment Charges Calculation on Home Loan: How it affects you?
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