Loan prepayment: should you reduce the EMI or the tenure?
After a part-prepayment, lenders ask whether to cut your monthly payment or the number of months left. A worked example shows which saves more interest, and when.
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Tools for this job: EMI Calculator · Loan Calculator
You have a bonus or some savings and decide to pay part of your home or car loan early. The lender then asks a question: keep the same EMI and finish sooner, or keep the same end date and pay a smaller EMI? The choice makes a large difference to the interest you pay.
Worked example
A loan of 20,00,000 at 9% for 15 years has an EMI of 20,285 and total interest of about 16.5 lakh. After three years, 36 EMIs, about 17,82,494 is still owed and 144 months remain. You prepay 2,00,000.
| Option | Result | Saved |
|---|---|---|
| Reduce tenure | EMI stays 20,285; 118 months left instead of 144 | about 3,32,900 |
| Reduce EMI | EMI falls to 18,009; 144 months left | about 1,27,800 |
Reducing the tenure saves more than two and a half times as much interest, and the loan ends more than two years early. Reducing the EMI frees up about 2,276 a month.
Why reducing tenure saves more
Interest is charged on the outstanding balance each month. When you keep paying the same EMI on a smaller balance, more of every payment goes to principal, so the balance falls faster, and each month's interest is smaller than it would have been. Cutting the EMI instead keeps the balance falling at the original slower pace, so you go on paying interest for the full term.
When reducing the EMI makes sense
- Your monthly budget is tight and a lower payment reduces real financial stress.
- Your income is uncertain and you want lower fixed commitments.
- You will invest the monthly difference at a return higher than the loan rate after tax, and you will actually do it every month.
For most people with a stable income, reducing the tenure is the better default.
Prepay early in the loan
The earlier a prepayment is made, the more it saves, because it removes principal that would have attracted interest for longer. The same 2,00,000 paid in year one saves more than in year ten. In the later years of a loan, most of each EMI is already principal, so prepayment saves relatively little.
Before you prepay
- Check for charges. Some fixed-rate loans carry a prepayment penalty. In India, banks are not allowed to charge one on floating-rate home loans taken by individuals, but check your loan agreement.
- Keep an emergency fund. Money paid into a loan is hard to get back if you lose your job.
- Compare with the rate. Prepaying a 9% loan is like earning a guaranteed 9% return. If you hold savings earning less, prepaying is usually better.
- Tax benefits. Where home-loan interest is tax-deductible, the effective rate is lower, which makes prepayment slightly less attractive.
Run your own numbers
Your lender's statement shows the outstanding principal. Enter that, the rate, and the remaining months into the EMI Calculator, then enter the balance minus your prepayment to see the new EMI. The Loan Calculator shows total interest for each case. The guide to how EMI is calculated explains the formula.