A common misunderstanding that sometimes trips a prepayment decision is the fact that the principal amount outstanding has not fallen substantially, even after making EMI payments for three to four years.

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In the earlier example of Rs 10 lakh, if the borrower decides to prepay at the end of fourth year, the outstanding principal is still nearly Rs 9 lakh. This is because the borrower is paying back a higher proportion of interest in the initial EMIs. The interest component could be anywhere near 80% in the initial months. Interest component comes down and principal component increases as a proportion of the EMI as the loan tenure matures.

This often leads to a common mistake of assuming that it is better not to prepay, say, after half way through the loan tenure, because the interest component is low now. But the fact is that the interest outgo as a percentage (which is what the interest rate is) on outstanding principal is the same whether it is after the 24th month or after the 120th month.

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Since interest rate on home loans is calculated using reducing balance method, the interest rate is always calculated on the remaining outstanding principal. As the remaining outstanding principal will be lower after 120 months compared to after 24 months, the interest amount which needs to be apportioned across the remaining tenure would also be lower, resulting in lower interest amount component.

But the interest rate on the remaining principal would be the same at both the time period. So the decision to repay one’s home loan should not be driven by the stage of your loan tenure but by prevailing interest rate and availability of cash with you.

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