Pros and Cons of Prepayment of Loans
Banks levy 2-3% of prepayment penalty on balance amount. This is because, the bank bank's profit on a loan is the interest component. Larger the repayment tenure, higher would be the interest earned by the bank. Therefore reduction in the time frame of the loan, reduces the interest the borrower pays to the bank, thereby reducing the profitability of the bank.
Some banks however, allow the customer to prepay the loan up to a certain amount without any fine, whereas some banks like State Bank of India, do not charge any penalty at all on prepaid loans, if the payments are made out of own funds.
Recent announcement of Reserve Bank of India prohibits banks from charging foreclosure penalty on home loans. State Bank of India already leads the pack in stopping foreclosure penalty on both fixed and floating rates home loans.
However there are certain benefits linked to prepayment. Prepayment of loan can be used to avail tax rebate u/s Section 80C. Other benefits include reduction of the tenure of the loan and also in reduction of the rate of interest charged.
Let us consider a Rs. 40,00,000 home loan with 13% interest rate and a tenure of 25 years. Also assume, 5 years of the tenure has passed, and the remaining time is 20 years. We calculated the EMI for the loan using Rupeetimes EMI Calculator, the EMI for the loan comes to Rs. 45,113.
Normal loan payment
If the borrower continues to service his/her loan as per the terms of the loan, he/she stands to pay
Total Interest : Rs. 69,76,558
Total Principal : Rs. 38,50,661
Total sum = Rs. 1,08,27,219