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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Debt Management and Loans

Ms. Kavita Rao has a home loan with an outstanding principal of Rs 40,00,000 at 8.5% per annum on a floating rate linked to an external benchmark. She also has a Rs 1,00,000 surplus. She prepays Rs 1,00,000 and keeps the EMI unchanged. Which outcome is correct, assuming no prepayment penalty and the rate stays constant?

The tenure reduces and total interest falls. Prepaying Rs 1,00,000 lowers the outstanding principal, and with the EMI unchanged the loan is repaid earlier. Interest is charged on a smaller balance each month, so the cumulative interest paid is lower.

  1. ALoan tenure reduces, and total interest paid over the loan life fallsCorrect
  2. BLoan tenure stays the same, and total interest paid is unchanged
  3. CLoan tenure increases, and total interest paid falls
  4. DLoan tenure reduces, but total interest paid rises

Explanation

A part-prepayment reduces outstanding principal. With the EMI unchanged, the loan clears sooner, so the tenure shortens. Interest each month is charged on a lower balance, so total interest falls. Under RBI norms, floating-rate loans to individuals carry no prepayment charges.

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