If you're carrying more than one loan - say a home loan, a car loan, and a personal loan - and you come into some extra money, which one should it go towards? The answer usually comes down to a short list of factors, roughly in order of importance.
1. Interest rate - usually the biggest factor
Every rupee you prepay on a loan effectively "earns" you that loan's interest rate, since that's the cost you're avoiding. Personal loans and credit-card-linked debt typically carry the highest rates, followed by car loans, with home and education loans usually at the lower end. All else being equal, prepaying your highest-rate loan first saves the most money.
2. Whether a prepayment charge applies
A high-rate loan is a less attractive prepayment target if it carries a prepayment penalty that eats into the saving, while a lower-rate loan without any charge might still come out ahead. Check our guide on prepayment charges and rules, and don't assume - confirm with each lender.
3. Remaining tenure
A prepayment made early in a loan's life saves more interest than the same amount prepaid near the end, because it removes the balance from accruing interest for longer. If two loans have similar rates, the one with more remaining tenure is often the better prepayment target.
4. Tax treatment, where relevant
In some countries, interest on certain loans (such as home loans, in parts of India under specific sections of the Income Tax Act) can carry tax benefits that reduce the loan's effective cost. This can tip the decision towards prepaying a different loan instead, even if the home loan's stated rate looks competitive. Tax rules change and vary by situation - this isn't tax advice, so check current rules or a tax professional for your specific case.
5. Peace of mind from closing a loan entirely
Numbers aside, some people simply prefer eliminating a loan completely - even a smaller, lower-rate one - for the psychological and practical benefit of one less monthly obligation and one less thing to track. There's nothing wrong with this being part of the decision, as long as you're aware it may not be the mathematically optimal choice.
Key takeaways
- Prepaying your highest-interest-rate loan first usually saves the most money overall.
- Check for prepayment charges before assuming the highest-rate loan is the best target - a charge can change the math.
- Loans with more remaining tenure generally benefit more from a prepayment than loans nearing their end.
- Tax treatment and personal preference for debt-free peace of mind are valid parts of the decision too.
Compare the actual numbers
Run each of your loans through the calculator with the same prepayment amount to see which saves more.
Frequently asked questions
Should I always prepay my highest-interest loan first?
As a general rule, yes - prepaying the loan with the highest interest rate typically saves you the most per rupee prepaid, since that's the rate you're effectively 'earning' by not paying it. The main exception is when a lower-rate loan carries a prepayment penalty that a higher-rate loan doesn't, which can change the math.
Is a home loan usually the lowest priority to prepay?
Often, yes - home loans typically carry lower interest rates than personal or car loans, and in India, individual floating-rate home loans usually have no prepayment penalty and may offer tax benefits on interest in some circumstances. That combination often (not always) makes other, higher-rate debt a better prepayment target first. This isn't tax advice - check current rules and your own situation.
What if two loans have similar interest rates?
When rates are close, compare prepayment charges, remaining tenure, and the psychological/practical value of closing a smaller loan entirely versus partially reducing a larger one. There's no single right answer - it depends on your priorities.