Which is financially smarter: Increasing EMI amount or prepaying the home loan?

Should I increase my EMI amount or prepay the home loan if I get a salary hike or an annual bonus? Which is financially smarter?

Reply By: Pankaj Gadgil, MD & CEO, Aditya Birla Housing Finance Limited.

If you’ve recently received a salary hike or annual bonus, it’s a good time to reassess your home loan repayment strategy. The decision between increasing your EMI or making a lump-sum prepayment depends on your financial priorities, income stability, and long-term goals. Here's a breakdown of both options to help you decide which is financially smarter:

Increasing EMI Amount

Pros:

Faster Loan Repayment: Increasing your EMI accelerates the repayment of the principal amount, reducing the loan tenure and total interest paid over time.

Consistent Commitment: It demonstrates financial discipline and can improve your credit score, as you are consistently making higher payments.

Flexibility: If your income increases regularly, you can adjust your EMI accordingly to utilise the extra funds effectively.

Cons:

Higher Monthly Commitment: You need to ensure you can sustain the increased monthly payments without straining your finances.

Prepayment

Pros:

Flexibility: Prepayment allows you to reduce your loan burden whenever you have surplus funds, such as bonuses, without committing to higher monthly payments.

Interest Savings: Prepaying reduces the outstanding principal, which in turn decreases the interest component and shortens the loan tenure.

Emergency Funds: Maintaining liquidity for emergencies or other investments by not locking funds into regular, higher EMIs.

Cons:

Opportunity Cost: Tying up funds in prepayments might limit your ability to invest in other potentially high-yielding assets.

The choice between increasing your EMI and prepaying depends on your financial situation and goals:

Stable Income and Higher EMI Preference: If you have a stable income and can comfortably manage higher monthly payments, increasing your EMI is a more effective way to reduce interest costs and shorten the loan tenure.

Irregular Income or Preference for Flexibility: If your income is irregular or you prefer flexibility, prepayment is a better strategy as it allows you to reduce your loan burden without committing to higher monthly payments
Key things to consider are your financial stability, liquidity needs, and investment opportunities before making a decision.

(Views expressed by the tax/investment expert are his/her own)