Why Home Loan Principal gets paid off slowly in the initial years?

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If you have taken a home loan and have seen how home loan EMI works, you would have realized that the home loan principal gets paid off very slowly during the initial years.

But why is it so? We discuss this aspect of home loans in this post.

First fix ourselves a scenario and then I will explain everything.

Suppose you want to purchase a house that costs Rs 62.5 lakh. For this you need to make 20% downpayment, i.e. Rs 12.5 lakh is to be brought in by you as a downpayment. The remaining amount is to be funded via home loan. So you have taken a home loan of Rs 50 lakh at 8% interest rate for a period of 25 years. For this, the monthly EMI is Rs 38,591. More importantly, for this Rs 50 lakh loan, you end up paying a total interest of Rs 65.8 lac during the full 25-year loan tenure.

And if we use a loan amortization table (see below), then this is how your home loan gets paid off in the above scenario:

50 lakh home loan amortization

If you notice that even after the first 5 years of regular payment, which is 20% of the loan tenure, only 7.7% of the loan is paid off.

And if we focus on 5-year periods, then there are FIVE 5-year periods of this 25-year loan. And this is how it looks:

  • After 5-years (20% of total tenure), 7.7% of the loan principal is paid off
  • After 10-years (40% of total tenure), 19.2% of the loan principal is paid off
  • After 15-years (60% of total tenure), 36.4% of the loan principal is paid off
  • After 20-years (80% of total tenure), 61.9% of the loan principal is paid off
  • After 25-years (100% of total tenure), 100% of the loan principal is paid off

So why is it that the outstanding principal amount reduce slowly during the initial years?

For this, we need to understand how home loan repayment works. You are already aware of EMIs or Equated Monthly Installments. Now this EMI is made up of 2 parts. First is the interest component on the outstanding amount and second is the principal component.

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Now let’s take the case of EMI in the above example.

Using the home loan EMI calculator, we know that the EMI is Rs 38,591 for a Rs 50 lakh home loan at 8% for 25 years.

Now let’s break this EMI into 2 components and see what part goes towards principal repayment and what part goes towards interest payment?

Month 1:

  • Outstanding Loan Principal at the beginning of month = Rs 50 lakh
  • Interest to be paid for month = 50 lakh * 8%/12 = Rs 33,333
  • Principal payment for month = EMI – Interest Payment = 38,591 – 33,333 = Rs 5258
  • Outstanding Loan Principal at the end of month = Rs 49,94,742

Month 2:

  • Outstanding Loan Principal at the beginning of month = Rs 49,94,742
  • Interest to be paid for month = Rs 49,94,742 * 8%/12 = Rs 33,298
  • Principal payment for month = EMI – Interest Payment = 38,591 – 33,298 = Rs 5292
  • Outstanding Loan Principal at the end of month = Rs 49,89,450

Month 3:

  • Outstanding Loan Principal at the beginning of month = Rs 49,89,450
  • Interest to be paid for month = Rs 49,89,450 * 8%/12 = Rs 33,263
  • Principal payment for month = EMI – Interest Payment = 38,591 – 33,268 = Rs 5328
  • Outstanding Loan Principal at the end of month = Rs 49,84,122

And this continues month after month for 25 years.

Did you notice something? Or rather three important things?

Let me highlight them to you:

  • A major chunk of your EMI goes towards interest servicing in the initial part of the loan
  • Every month, a slightly large amount (than the previous month) goes towards principal repayment.
  • So every month, the interest payment for the month goes down while principal repayment goes up.

Have a look at the annual loan amortization table above again. You will realize that the interest component paid is higher during the initial years. During the latter years, the principal component is higher. With each passing month’s EMI, the interest paid decreases and the principal repaid increases. Many people know this. But many don’t. Do spend some time studying the earlier table.

And let me show you the monthly EMI table for 1st one year:

Home loan amortization schedule 1

And here is the table for the 11th year:

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Home loan amortization schedule 2

Notice the difference. The monthly EMI is same. But the amount that is going towards interest payment gets lower and lower after each month. Consequently, the amount of principal being repaid every month keeps on increasing every month.

So now you know how the EMI composition changes every month even though the EMI amount remains the same.

Now don’t make the mistake of thinking that if it’s a 25-year loan, then you would have paid back half your loan in 12-13 years. The actual amount you have repaid would be about 23-24% only.

You can see the bulk of the EMI payments during the initial years goes towards interest payment. If you have a home loan, just ask your lender for the home loan amortization table. It will indicate what exactly is your outstanding home loan amount at any point in time. And if you don’t know what Loan Amortization Schedule is, then here is a short explainer – A loan amortization schedule shows the monthly/annual breakup between the principal and interest components of the home loan. It is something similar to the schedule shown in the table earlier.

And it is for this reason of front-loading of interest payment, that if you want to make a part prepayment of your home loan, then it’s better to do so in the initial years itself.

So suppose you want to make a one-time prepayment of Rs 5 lakh in your Rs 50 lakh home loan. Let’s see how the total interest paid during the 25-year tenure is impacted depending on when you make the prepayment:

  • No Prepayment: Total interest paid Rs 65.7 lakh
  • Prepayment of Rs 5 lakh in 1st year: Total interest paid Rs 42.7 lakh
  • Prepayment of Rs 5 lakh in 2nd year: Total interest paid Rs 44.4 lakh
  • Prepayment of Rs 5 lakh in 3rd year: Total interest paid Rs 46.1 lakh
  • Prepayment of Rs 5 lakh in 4th year: Total interest paid Rs 47.6 lakh
  • Prepayment of Rs 5 lakh in 5th year: Total interest paid Rs 49.1 lakh
  • Prepayment of Rs 5 lakh in 6th year: Total interest paid Rs 50.5 lakh
  • Prepayment of Rs 5 lakh in 7th year: Total interest paid Rs 51.8 lakh
  • Prepayment of Rs 5 lakh in 8th year: Total interest paid Rs 53.1 lakh
  • Prepayment of Rs 5 lakh in 9th year: Total interest paid Rs 54.3 lakh
  • Prepayment of Rs 5 lakh in 10th year: Total interest paid Rs 55.4 lakh
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So prepaying RS 5 lakh in the first year will result in savings of Rs 23 lakh (i.e. Rs 65.7 lakh – Rs 42.7 lakh) over the course of full tenure. But prepaying the same amount instead in the 10th year will only result in savings of about Rs 10 lakh (i.e. Rs 65.7 lakh – Rs 55.4 lakh).

To state the obvious, the earlier you make the prepayment(s), better it is for you in terms of its impact on reducing the total interest paid during the tenure.

Just remember that when you opt for long tenure loans (like home loans), a major part during the first few years is only about paying interest. That is, the interest is front-loaded.

And if you are planning to pay off your loan as early as possible and become loan-free, then I suggest you read this post on How to prepay of Rs 50 lakh loan quickly? After reading it, you will realize that just by pushing yourself a bit and paying a few extra thousand rupees every month can save you a lot of money in the long run. And it also reduces your loan tenure substantially. So don’t worry if you do not have any lumpsum to prepay the home loan. Even the small periodic pre-payments can make a big difference and save you a lot of money in the long run.

Further readings:

Purchasing a house is one of the biggest financial decision for most people in India, both financially (2021). I hope you found this analysis of why does outstanding principal amount reduce slowly in home loans useful. Do share it with others too.



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Dev Ashish
A SEBI Registered Advisor and founder of Stable Investor, Dev Ashish is helping people achieve their Financial Goals & Invest profitably.
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