A prepayment penalty is a fee or charge, that you need to pay to the bank if you opt to repay a loan before the end of its term.RBI allows banks to calculate prepayment charges only on the outstanding loan amount. Typically, the longer you’ve had your loan, the lesser your outstanding loan, and therefore the smaller your penalty.
Floating rate home loans taken by individuals are exempt from prepayment fees. For others, banks charge a prepayment penalty of 2-3% on the outstanding loan amount at the time of prepayment.
All borrowers are, ironically, averse to being debt ridden. It’s natural to want to repay your loan at the earliest and prepayment allows you to try to do just that. Prepayment is a facility that helps you repay your housing loan (in part or full) if you've got surplus funds before the completion of your loan tenure. This reduces the outstanding principal owed, and successively reduces your EMIs or the remaining loan tenure.
Doing a prepayment or part-prepayment on your home loan will reduce the housing loan tenure/EMI. Once you make a home loan prepayment, you get two options:
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To reduce the EMI amount and keep the tenure same
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To reduce the tenure and keep the EMI same
As a borrower, it’s natural to plan to close your loan before time to scale back your borrowings and monthly interest burden. However, make sure to check the prepayment penalties to decide if the savings are worth it. Compare the savings you get on pre closing the loan with the prepayment charges to decide if terminating the loan before the tenure is worth it.
Additional Reading: 6 Smart Ways To Prepay Home Loan