In short
- Prepayment reduces total interest because it cuts the balance interest is charged on.
- Whether it is right depends on your other uses for that money, and on keeping a reserve.
- Check the prepayment terms first — they differ by rate type and by lender.
Why prepayment works
Interest is charged on the outstanding balance. Pay down the balance and there is less to charge interest on, so the total cost of the loan falls. Because a home loan's instalments are interest-heavy in the early years, a prepayment made early saves more than the same amount paid later.
The case for prepaying
- A guaranteed saving equal to the loan's interest rate, with no market risk.
- A smaller debt and, if you reduce the tenure, an earlier finish.
- Certainty — the saving does not depend on markets performing.
The case for caution
- Money paid into a loan is illiquid; it cannot be called on in an emergency.
- Adequate emergency reserves should come first, before aggressive prepayment.
- Costlier debt — credit cards, personal loans — should generally be cleared before a home loan.
Check the terms
Prepayment and foreclosure terms differ by lender and by rate type, and they have changed over time. Get the terms for your specific loan in writing before you decide, because a charge that looks small against the interest saved can change the arithmetic.
Reduce the tenure or the instalment?
Most prepayments can be applied either to shorten the remaining tenure or to reduce the monthly instalment. Keeping the instalment and shortening the tenure usually saves more interest, because the loan finishes sooner. Reducing the instalment eases monthly cash flow instead. Decide which you actually need.
The honest rule of thumb
Clear your most expensive debt first. Keep enough reserve to absorb a bad few months. Then decide about the cheapest debt — usually the home loan — based on whether the guaranteed saving is worth more to you than liquidity and peace of mind.
Questions this raises
Does prepaying shorten my loan?
- It can, if you choose to reduce the tenure rather than the instalment. Tell the lender which you want.
Is prepaying better than investing?
- There is no universal answer. The loan rate is a guaranteed, tax-adjusted saving; market returns are neither guaranteed nor comparable in risk. The right choice depends on your circumstances and on what lets you sleep.
Read the full guidance on home loan.