Every once in a while, money shows up that you were not planning for. A bonus. A tax refund. A client who finally paid. Maybe you sold something. Or you just saved more than usual that month.
Most people spend it. Some people park it in a savings account earning 3 to 4 percent interest per year. And then there is the third option and putting it towards your loan is which most people either do not think about or assume is complicated.
It is not complicated. And the difference it makes is bigger than most people expect.
What Actually Happens When You Make a Part Payment
When you pay your regular EMI every month, the money is split between interest and principal. In the early months of a loan, most of your EMI goes towards interest. Very little actually reduces what you owe.
A part payment works differently. The entire amount you pay goes directly towards reducing your outstanding principal. No portion of it goes to interest. That one fact is what makes it so powerful.
When your principal drops, the interest calculated next month is lower. Which means more of your next EMI goes towards principal. Which lowers it further. The effect compounds quietly, month after month, for the rest of the loan.
The Two Choices You Get
When you make a part payment, most banks give you two options. You can either keep your EMI the same and reduce the total number of months left on your loan, or keep the tenure the same and get a lower EMI going forward.
Reducing the tenure saves you more money overall. Reducing the EMI improves your monthly cash flow. Both are valid depending on your situation, but if the goal is to pay the least possible interest, reducing tenure wins every time.
Real Numbers So This Actually Makes Sense
Loan amount: Rs. 10,00,000
Interest rate: 10.5% per year
Tenure: 5 years (60 months)
Monthly EMI: Rs. 21,491
Total interest without any part payment: Rs. 2,89,460
Now say at the end of month 12, you receive a bonus of Rs. 1,00,000 and you put the entire amount as a part payment towards your loan.
Outstanding before part payment: Rs. 8,34,272
Outstanding after part payment: Rs. 7,34,272
If you choose to reduce tenure:
Remaining months drop from 48 to 38
Total interest paid now: Rs. 2,25,140
You save Rs. 64,320
And you get out of debt 10 months earlier.
One payment. One decision. You saved over 64,000 rupees in interest and finished your loan almost a year ahead of schedule.
That same Rs. 1,00,000 in a savings account at 4% would have earned you around Rs. 4,000 over that same period. The math is not close.
The Earlier You Pay, the More You Save
This is the part most people miss. Making a part payment in month 6 saves you significantly more than making the same payment in month 40. The reason is simple. The earlier you reduce the principal, the more months there are left for that reduction to have an effect on your interest calculation.
If your loan has 10 months left, making a part payment of Rs. 50,000 will save you a relatively small amount. If your loan has 48 months left, that same Rs. 50,000 works for 48 months compounding your savings every single month.
What About Prepayment Charges
Some loans charge a fee if you pay ahead of schedule. For floating rate loans, RBI guidelines prohibit banks from charging prepayment penalties on individual borrowers. So if you have a home loan at a floating rate, you can make part payments without any penalty.
For fixed rate loans and personal loans, some lenders do charge a prepayment fee, typically 2 to 4 percent of the amount being prepaid. Before you make a part payment, check your loan agreement or call your bank to confirm if a penalty applies. In most cases, even with a 2 percent fee, the savings from reducing the principal still outweigh the cost.
Multiple Part Payments Work Even Better
You do not have to wait for a large windfall. Multiple smaller part payments throughout the loan work just as well, sometimes better. Rs. 20,000 paid in month 6, another Rs. 30,000 in month 14, and Rs. 50,000 in month 24 can save you more than a single Rs. 1,00,000 payment made in month 20.
The key is to make the payment as early as you can, with whatever amount you have available at that point. Do not wait to accumulate a big round number if you have money sitting idle now.
Not sure when to make a part payment and when it might not make sense? Read the next article on exactly that.
Frequently Asked Questions
Most banks give you the choice. Reducing tenure saves more interest overall because the loan closes earlier. Reducing EMI gives you more cash flow each month. If you can afford the current EMI, reducing tenure is almost always the better financial decision. You can model both options in the EMI calculator on this site to see the exact difference for your loan.
It varies by lender. Most banks require a minimum of one EMI amount as a part payment. Some have a fixed minimum like Rs. 5,000 or Rs. 10,000. Check your loan agreement or call your bank before transferring the amount. There is usually no upper limit on how much you can prepay in a single transaction.
Yes, but personal loans often have prepayment penalties unlike floating rate home loans. Typically 2 to 4 percent of the amount prepaid. Even with this penalty, if you are early in the loan tenure, the interest savings usually outweigh the penalty. Calculate both before deciding. The EMI calculator lets you see your savings before you commit.
For most home loans, banks have a lock-in period of 6 to 12 months before allowing part payments. For personal loans it is often 6 months. After the lock-in, you can usually make part payments at any time. Confirm the lock-in period with your lender when you take the loan so you can plan accordingly.
The earlier the better. In the first half of your loan tenure, a large portion of each EMI goes toward interest. A part payment made early reduces the principal on which interest is calculated for all remaining months. The same amount paid in the second half of the loan saves significantly less because most of the interest has already been paid.