Why small extra payments do so much
Extra money applied to principal permanently removes that amount from every future interest calculation. On a 200,000 loan at 8.5% over 20 years, adding just 200 a month typically saves tens of thousands in interest and clears the loan several years early.
The effect is strongest early, because that principal would otherwise have compounded against you for the longest time. A prepayment in year one is worth several times the same prepayment in year fifteen.
Should you prepay or invest instead?
Compare your loan rate against the return you could reliably earn elsewhere, after tax. Prepaying a loan at 8.5% is a guaranteed, risk-free 8.5% return. Beating that in the market requires taking real risk, so prepaying high-rate debt is usually the better move.
The exception is very low-rate debt. If your mortgage is at 3% and safe deposits pay 5%, the arithmetic favours investing. Also check whether your lender charges prepayment penalties, which are common on fixed-rate products.
Frequently asked questions
Should I reduce my EMI or my tenure?
Reducing tenure saves far more interest. Reducing the EMI improves monthly cash flow but keeps you in debt for the full original term.
Are there prepayment penalties?
Often on fixed-rate loans, rarely on floating-rate ones in many markets. Check your agreement before committing to a prepayment plan.
Is it better to prepay in a lump sum or monthly?
Earlier is always better, so whichever you can do sooner. Regular monthly extras are easier to sustain and automate.
Should I prepay my mortgage or invest?
Compare the loan rate to your realistic after-tax investment return. Prepayment is a guaranteed return at your loan rate, which is hard to beat on a risk-adjusted basis for high-rate debt.
Will my lender apply extra payments to principal automatically?
Not always. Some apply them to future installments instead. Instruct your lender explicitly that extra payments should reduce principal.
Does prepaying hurt my credit score?
No. Reducing debt generally helps. Closing the account entirely may slightly shorten your credit history, but the financial benefit far outweighs that.