The home loan and what prepayment does

The loan is usually the largest financial contract of a person's life, and the least examined.

Amortisation, and why the early years feel futile

An EMI is constant. What it is made of is not.

Each instalment pays the interest accrued on the outstanding balance, and whatever is left reduces the principal. Early on the balance is large, so interest consumes most of the payment. As the balance falls, interest falls, and more of the same EMI goes to principal.

Stage of a 20-year loan	Roughly what the EMI is doing
Year 1	Overwhelmingly interest
Year 10	Approaching an even split
Year 20	Overwhelmingly principal

This is why prepaying early is worth so much more than prepaying late. A rupee of principal removed in year two avoids interest on that rupee for eighteen remaining years. The same rupee removed in year eighteen avoids two years of it. The benefit of prepayment is front-loaded, and it is the reverse of how most people's capacity to prepay develops.

It is also why the first years feel like running in place: the balance barely moves, and nothing is wrong.

Leverage, honestly

Borrowing to buy magnifies the return on the money you actually put in, in both directions. Chapter 1 flagged this as the most misunderstood thing in Indian household finance.

Take a ₹80 lakh property with ₹16 lakh down.

If the property rises 10% to ₹88 lakh, the gain is ₹8 lakh on ₹16 lakh of your own money — 50% on your equity.

If it falls 10% to ₹72 lakh, you have lost ₹8 lakh of ₹16 lakh — half your equity gone, on a 10% move.

Neither figure is the property's return, which was ±10%. Leverage did not make the asset better or worse; it changed how much of the outcome lands on you.

Two consequences people miss:

The interest is a drag the asset must overcome. At 8.5% on ₹64 lakh, the loan costs about ₹5.4 lakh in year one. The property must appreciate by roughly that much just to stand still against the financing.

Negative equity is possible. If the price falls far enough, the loan exceeds the property's value, and you cannot sell without finding the difference in cash. Nothing about owning a home prevents this.

Floating rates, and where they come from

Most Indian home loans float against an external benchmark, which the Financial institutions subject covers. Two practical points from there:

When the policy rate falls, most lenders shorten the tenure rather than cut the EMI, so the benefit is real and invisible in your monthly payment. Ask explicitly which your lender does, and ask them to change it if you want the other.

The spread over the benchmark is the lender's, and it was set when you borrowed. The benchmark transmits automatically; the spread does not improve because you have been a good borrower.

The prepayment rule, which changed in 2026

This is the most useful fact in the chapter, and it is new.

Under the Reserve Bank of India (Pre-payment Charges on Loans) Directions, 2025, applicable to loans sanctioned or renewed on or after 1 January 2026:

For all loans granted for purposes other than business to individuals, with or without co-obligant(s), an RE shall not levy pre-payment charges

And the reach of that is unusually wide:

The Directions ... shall be applicable irrespective of the source of funds used for pre-payment of loans, either in part or in full, and without any minimum lock-in period.

Three scoping points, because getting these wrong matters:

It applies to floating rate loans. Paragraph 5 opens by addressing "all floating rate loans and advances". A fixed-rate loan is not covered by this provision, and for a dual or special rate loan the answer "will depend on whether the loan is on floating rate at the time of pre-payment."

"Purposes other than business" covers a home loan for your own use. A loan taken for business purposes falls under a separate paragraph with its own conditions by lender type.

The commencement date matters. The Directions apply to loans sanctioned or renewed on or after 1 January 2026. An older loan is governed by the rules that applied to it — though floating-rate home loans to individuals have been free of foreclosure charges under earlier RBI instructions as well, so check your own sanction letter, where applicability must now be clearly disclosed.

The RBI's stated reason is worth noting: supervisory reviews found lenders including restrictive clauses "to deter borrowers from switching over to another lender, either for availing lower rates of interest or better terms of service." The rule exists to make switching possible — so if your spread is uncompetitive, the barrier to moving has been deliberately removed.

Working the problem

₹5 lakh spare, loan at 8.5% with 15 years left.

What prepaying earns. It removes ₹5 lakh of principal, avoiding 8.5% on it for the remaining term. That saving is certain, immediate, and not taxable — you are not earning income, you are not incurring an expense.

What an investment must beat. To match a certain, tax-free 8.5%, an investment must return 8.5% after tax. At a 30% slab that means a pre-tax return of 8.5 / (1 − 0.30) = about 12.1%, as the Deposits and small savings subject's EEE chapter sets out.

So the comparison is: a guaranteed 8.5% after tax, against an uncertain 12.1% before tax. That is a high bar, and it is why prepaying is usually right.

What would have to be true for investing to win:

A long horizon in a growth asset, and the temperament to hold it. Equity has historically returned more than 12% before tax over long periods, but not reliably over short ones, and the Behavioural finance subject documents what happens to people during drawdowns. The comparison is only valid if you would actually stay invested through one.

A tax-exempt wrapper. Inside something taxed at neither accrual nor withdrawal, the hurdle falls back toward 8.5% rather than 12.1%, which changes the arithmetic materially.

A low tax slab. At 5%, the required pre-tax return is about 8.9% rather than 12.1%, and the bar is far easier.

No emergency fund yet. This is the one that actually decides it for most people, and it argues for neither: prepaying converts liquid money into illiquid equity in a house, and a prepayment cannot be reversed when you need cash. Build the buffer first, then choose between the other two.

Liquidity is the real cost of prepaying, and it is the thing the interest-rate comparison misses entirely. Since the RBI Directions remove the charge, the remaining question is not "what will it cost me to prepay" but "what will it cost me not to have that money".

The point

An EMI is constant while its composition is not, so early instalments are nearly all interest and a rupee prepaid in year two avoids far more interest than the same rupee in year eighteen. Borrowing magnifies the return on your own money in both directions — a 10% price move becomes a 50% swing on a 20% deposit — and the interest is a drag the asset must first overcome. Since the RBI's 2025 Directions, floating-rate loans to individuals for non-business purposes carry no prepayment charge, from any source of funds, in part or full, with no lock-in. Prepaying returns a certain tax-free rate, which an investment must beat after tax; the real argument against it is liquidity, not cost.