Why prepayment can save interest

Loan interest is generally calculated on the outstanding principal. Paying part of that principal early can reduce the balance used for future interest calculations. The actual saving depends on timing, rate, remaining tenure and lender rules.

Option 1: keep the EMI

If the EMI stays the same after a prepayment, more of each future payment can reduce principal and the loan may finish earlier. This approach often creates a larger interest saving because the balance remains outstanding for fewer months.

Option 2: reduce the EMI

If the lender keeps the original end date, it may recalculate a lower monthly payment. This can improve cash flow, but the loan continues for longer than it would under a tenure-reduction option.

Questions to ask the lender

  • Are there prepayment fees or minimum amounts?
  • Will the EMI or the tenure change by default?
  • When will the payment be credited to principal?
  • Will the lender issue a revised amortisation schedule?
  • Does the interest rate change under any condition?

Compare with your alternatives

Keep an adequate emergency fund before committing spare cash. Also compare the certain loan-interest saving with the risk, return, tax and liquidity of other uses for the money.

A prepayment calculator is a scenario tool. Your lender's written schedule and terms determine the actual saving and revised repayment plan.