Owning a home is a big dream for middle class families. But to fulfill this dream, most of the people take home loan and if the loan tenure is 30 years, then the whole life is spent in paying EMI. In these 30 years, you have to pay more in interest than the loan amount taken.
For example, if you take a home loan of Rs 1 crore for 30 years at an annual interest rate of 7.5%, your monthly EMI will be Rs 69,921. In these 30 years, you will pay Rs 1.51 crore only as interest on the principal amount of Rs 1 crore, which means the total payment will be Rs 2.51 crore.
Misconceptions among borrowers about EMI: Many people believe that paying an EMI of ₹69,921 reduces the principal amount of the loan by that much, but in reality it is not so. In the initial years, almost 90% of the EMI of ₹69,921 (approximately ₹62,500) is deducted as interest, while the principal amount is reduced by only ₹7,421. For the first 15 years, a major part of the EMI goes towards paying interest. Only after 15 years the principal amount starts reducing rapidly.
There are two effective ways to repay home loan early: 1. 'Plus One' formula in home loan. According to this formula, you will have to pay 1 additional EMI every year in addition to the regular 12 EMIs (i.e. total 13 EMIs per year). While paying regular EMIs, a large part of it goes towards interest, but this 13th additional EMI is directly deducted from your principal amount. If you start paying just 1 additional EMI every year, your 30 year home loan can be repaid in just 23 years and 7 months.
2. Formula for EMI increase of 10% every year: As your income or salary increases annually, increase your home loan EMI by 10% every year. For example, if your monthly EMI is ₹20,000, increase it by 10% to ₹22,000 in the second year and again by 10% the year after that. By continuing with this method, the 30 year loan will be completed in just 11 years and 2 months.
Get rid of the loan in less than 11 years by adopting both methods: If you apply both the 'Plus One' and '10% Annual Increase' methods together (i.e. pay 13 EMIs every year and also increase the EMIs by 10% every year), your 30 year home loan will be completely repaid in just 10 years and 6 months. The simple rule of closing the home loan early is to reduce the principal amount as quickly as possible, which automatically reduces the interest burden.