Prepayment

Prepayment refers to the early repayment of a loan, bond, or fixed-income instrument — in full or in part — before the scheduled maturity or contractual repayment date. For borrowers, prepayment reduces the outstanding principal, lowers future interest obligations, and reduces the total cost of credit over the loan tenure. For lenders and bond investors, prepayment creates reinvestment risk — the returned principal must be reinvested at prevailing (potentially lower) interest rates, reducing the income previously anticipated from the original investment. In India, the RBI mandates that all floating-rate home loans from banks and housing finance companies must be pre-payable without any prepayment penalty for individual borrowers — encouraging home loan borrowers to pay down principal early when surplus funds are available. For fixed-rate loans and NCD investments, prepayment may attract penalties compensating the lender for the loss of contracted interest income. For mortgage-backed securities and fixed maturity plan (FMP) mutual funds in India, prepayment of the underlying loans reduces the fund's expected return profile — a risk specifically disclosed in the scheme information documents of debt mutual funds with mortgage loan or ABS exposure. Home loan borrowers in India typically make annual lump sum prepayments using bonus income or windfall receipts — directing surplus savings toward principal reduction rather than additional investments — a financially efficient strategy when the loan interest rate exceeds the expected post-tax return on alternative investments.