Why you must thank RBI for ending penalties on pre-paying home loans

Last week, the Reserve Bank of India gave millions of home loan borrowers respite from pre-payment penalties on floating rate home loans. but how exactly does that benefit you?

Presently, whenever you make a part-payment towards your loan, the payment goes towards repaying the principal amount of the loan. And when the principal amount reduces, the amount you pay as interest also is reduced.

Here’s an example of how that works:

Let’s assume you’ve taken a home loan of Rs 10 lakh for 20 years. Your current rate of interest is 11 percent.

So the total interest you pay on the loan is Rs 14,77,280. The total cost of the loan is Rs 24,77,280 (Rs 10,00,000 + Rs 14, 77,280).

Assume you’ve serviced the loan for 12 months, and the new loan outstanding is Rs. 9,85,417.

Now if you pay Rs 10,000 every six months, starting from the 13th month of the loan, the net interest you pay would drop to about Rs 9.5 lakh from about Rs 14.77 lakh. Your saving comes to around Rs 5.26 lakh.

This clearly shows that pre-paying a loan benefits you tremendously. Now with no pre-payment penalty, the amount you save is even higher. For the above example, if a pre-payment penalty of, say, around 3 percent was still applicable on the sum of all pre-payments made, the prepayment fee would have added up to Rs 7,800. But, with the apex bank’s new move, you can even save this amount.

But, that’s not the only benefit. Listen to the podcast above in which personal finance editor Bindisha Sarang gives you a complete lowdown of how the RBI’s provision benefits you.