How to reduce your home loan tenure?

This is a story of how I brought my home loan tenure down to under 10 years from 30 years. And how, with some planning, you can too. Welcome to my series ‘In Pursuit of Financial Freedom ‘ where I share my financial journey so you can learn from my experiences and mistakes. And hopefully, in the process, you and I can achieve Financial Freedom.

There is always a huge debate when it comes to renting vs buying a house. I have been on both sides of the debate from time to time. And this post is not about that (maybe a future post on that topic). I did finally decide to buy a house in early 2018. After some house-hunting, I zeroed in on a place and by May 2018, I had booked it. I live in Mumbai, so obviously I had to take a huge home loan to be able to afford the house. And using the word ‘huge’ for the loan is still an understatement. I wasn’t mentally prepared for the EMIs I started paying. Because it was more than twice the rent I was paying previously.

But the biggest shock was delivered when my rate of interest increased. I had taken the loan at an 8.55% interest rate. But, since the loan was a ‘floating-rate interest’ one and not a ‘fixed-rate interest’, my interest rate increased to 9.05%. And with that, my home loan tenure increased from 30 years to 37 years!! And with that, I decided that enough was enough. I was not going to spend the next 37 years paying off my home loan. And I decided to do everything I could to bring my home loan tenure down.

Now, let’s jump straight into how to reduce your home loan tenure –

1. Understand how home loans work –

This will not directly lower your tenure but it will give you tools to do so. Understand how your current home loan works. Say you take a loan of 1 Crore for 30 years at the rate of 8.5%. Your EMI comes to 76,891. Now, after paying a year of taking the loan and paying EMIs, you check your principal amount and see that it has been reduced by only 76,000. This basically means your 11 EMIs went towards interest and only 1 EMI towards the actual principal. And that is a scary thought! But that is how home loans work. Your principal and interest are not evenly spread across your tenure. The below chart shows how your EMI is distributed across the 30 years for the example above –

2. Make Pre-payments

This is the obvious way of reducing your home loan term. Pre-payments are directly against the principal amount. And they are the best way to reduce your loan tenure. Say you have a loan of 1 Cr for 30 years. And you make a pre-payment of 10 lakh rupees in the initial 2-3 years. That 10 lakh might seem small compared to the total principal, but it can effectively reduce your tenure by 8-10 years depending on your current interest rate! So by reducing your principal by even 10% can lead to reducing your tenure to 30+%. Some points to consider while doing a pre-payment –

• Everytime you make a prepayment you get an option to reduce your EMI or reduce your tenure. Always choose the option to reduce your home loan tenure. Unless your financial situation has changed and you can’t afford that EMI.
• Always plan to make a certain pre-payment in the year. Once you have a target set, it is easy to work towards it. You can do this by saving extra per month or making short term investments or using your annual bonus or any lumpsum amount you get during the year.
• The earlier you make the pre-payments, the better. Like you see in the chart above, towards the end of your loan tenure you majorly pay your principal as against the initial years when you majorly pay the interest.

In my case, pre-payments have been the driving force in bringing my home loan tenure down drastically.

3. Interest rate movements and conversion

This is applicable only to floating-rate loans (which form the majority of loans these days). Your loan interest rate is linked to the market interest rates. The interest rates refresh every quarter or every month depending on your loan provider. This means that your interest rate can either increase or decrease based on the market rates. As I mentioned above, it increased for me in the initial few quarters, which made my 30 year home loan into a 37 year one. But, currently, due to the pandemic, the market rates have drastically reduced. This means my interest rate has also reduced and now it is close to 7%. This has also helped reduce my home loan tenure but this is something that is outside of your control.

What you can control is interest rate conversion. You should always keep an eye out for the current market rate for your loan amount. Say you are paying 8.5% for a 1 Cr loan on ABC bank. But for the same amount, XYZ bank is providing an interest rate of 7.5%. You should immediately reach out to your current provider and ask to reduce your interest rate or consider refinancing with XYZ bank. Usually, even the mention of refinancing is good enough to scare your current provider and reduce your interest rate. I have been successful in reducing my interest rate twice already and I plan to reduce it further as I find better options with different providers.

4. Increase your EMI

When my first EMI started, I felt a huge pinch on my wallet because it was more than 60% of my monthly income and that is far from the ideal scenario. It meant I had to live below my means for a couple of years and reduce my investments. But as time passed by and my earnings increased, it becomes easier to manage. And I realized just how our income increases over time, why can’t our EMIs? With some research, I found that this was a very common practice and it was very straightforward. All I did was contact the loan provider and ask them to increase my EMI and they did that within a few minutes. No questions asked.

So, as your monthly income increases, consider increasing your EMI in proportion as well. If not the same percentage, at least a little bump will surely go a long way. I recently bumped up my EMI by 10% and it reduced my home loan tenure by 2 years!

5. Other ways to reduce your home loan tenure –

I have used the 3 methods I spoke about above. And I can vouch for them. But there are some other ways to reduce your home loan tenure too like –

1. Refinance – If you know that a different bank or loan provider is giving the same loan amount at a lower interest, and if you have already reached out to your current provider for conversion without any luck – you shoulld consider refinancing.
2. Pay an extra EMI every year – This is technique a lot of financial advisors recommend if you can’t do big lumpsum prepayments. It basically means that you pay 13 EMIs to the bank instead of 12. You would be surprised at how big of a difference it makes on your final loan tenure.

Pros vs Cons of reducing your home loan tenure –

Like any other financial decision, it is important that we weigh down the pros and cons. So you can make a sound decision that is relevant and best for you. Just because I prefer to reduce my home loan doesn’t mean that you should too. So let’s start with the pros first –

• Reduces your overall interest burden – When you reduce your tenure it is obvious that you will pay interest only for the years or months left. So the overall money you pay back to the loan provider is much, much lower as compared to when you keep paying EMIs for the entire tenure.
• Gives you mental peace – This is a big one for me. Knowing that my I will be debt-free sooner gives me a good night’s sleep (rather one less thing to worry about :p)

Let’s talk about the cons of reducing your home loan tenure –

• Leaves you with less money to invest – Home loans have the lowest interest as compared to any other debt options out there. And theorectically you can make more money by investing the additional money you use for pre-payments. If you choose to invest that money in equity and you get a return of 10-12%, it means you can pay-off the loan with those gains and still have some profit left for you. This is a long term scenario though.
• You might need to live below your means for a few years until you get comfortable with your EMIs. Baically you would need to let go of some of your wants in order to maintain the investments and needs.

Conclusion

You should always weigh the pros and cons of reducing your home loan tenure and take a relevant decision. But if you decide to join me, the above methods will definitely help you achieve your goal of reducing the home loan tenure. And in my case, it made a big difference where it had reached 37 years at a point and now it is around 7 years! I basically saved 30 years of my life (at least that is how I like to see it). Could I have made money by investing it instead of the prepayments? Maybe. And I didn’t compromise my investments. I reduced my wants instead. And it isn’t as difficult as it sounds. My plan for the future is to be debt-free within 5 years so I can drastically bump my investments.

I hope you found this post useful and I hope this will help in your financial journey. What were some of your financial mistakes? What is your approach? Do you like to reduce the tenure or reduce your EMIs? Please mention in the comments below and subscribe to my blog and stay tuned for future posts!