# Paying off a higher interest loan using a lesser interest loan

I took a loan for 3,000,000 at 9.2% from a bank for a period of 4 years (I need this much for my purpose). EMIs (equated monthly installments) are calculated based on a reduced balancing basis and works out to be around 75000 (EMIs have not started as of now). Now, my loan paying capacity per month is 95000. Also, I have access to an amount of 600,000 flat-rate loan at 4% for a year which also have the nice condition that there are no EMIs and I can pay it back in parts or full in any time in the year (4% of the total amount has to be paid back . Given my paying capacity, is it a good idea to take this lesser loan of 600K, prepay the original loan for by that much. In details, finish the lesser loan in 6 months (7*95K), then retake it again and so on.

• If you can refinance to a lower interest rate (which seems to be what you are asking about) without having to pay an unreasonable amount in fees, you can generally save money by doing so. But to get the lower rate you may need to shorten the term of the loan and wind up paying more each month. -- assuming you can get that lower-rate loan at all, and that your existing loan allows paying it off early. Run the specific numbers -- most banks have a tool on their website which can help you determine whether refinancing makes sense. Dec 31 '16 at 4:56
• It's not clear to me what happens with the EMIs if you take out the small loan and pay them. Do you still have to pay monthly? Do you skip that amount in payments (i.e. if you pay off as much as eight EMIs in a lump sum, do you skip eight EMIs)? Do your EMIs get smaller? I.e. if you pay off a fifth of the loan, are your EMIs reduced by a fifth? When you say this is a flat-rate loan, what does that mean? Do you pay 4% of the loan amount regardless of when you pay it back? Writing up examples might help you as well as us. Which country often matters. Dec 31 '16 at 4:58
• @Brythan The smaller loan is flat-rate. I have to pay back 24000 as (4% of 600K) whenever I wish to pay it back in a year in addition to the principal 600K. For the larger loan, I make a lump sum payment of 600k. Then, this payment goes towards the principal. The emi now remains same. However, 3 years now get reduced. Dec 31 '16 at 5:39
• The 3 years gets reduced at the end? So you only have 20,000 (20k) to pay off the new 624k loan? Or you can skip the next eight EMI payments (600k/75k = 8)? Plus a little extra at the end for reduced interest. Then you'd have twenty-eight months of payments left on the big loan. Possibly a little less. I'm also having trouble making the numbers add up. The 75k payment doesn't seem to pay off the loan in three years at 9.2% interest. It does pay off a four year loan that is otherwise the same. Dec 31 '16 at 6:00
• Can you double check your numbers? I agree with Brythan, 3000000 at 9.2% for 3 years would be a payment of 95679/month. At 4 years it would be 74940/month.
– TTT
Dec 31 '16 at 17:49

TL;DR: NO, you should not use it the way that you suggest using it.

I threw this into a spreadsheet. The result that I got by following your method (borrow 600000 and pay the next eight monthly payments with it; then pay 95000 per month against the flat-rate loan until the 600000 is paid) is paying off the loan after thirty-nine months rather than the forty-eight with monthly payments of 75000.

This seems to be due to paying 95000 a month rather than 75000. If I just change to 95000 without playing with the smaller loan, the loan gets paid off in just thirty-six months. That's actually cheaper than the other loan, presumably because you would normally only pay half of the interest on that 600000 (interest payments normally reduce during the loan). Also, the flat 4% is paid on only eight months borrowing, so it annualizes to something like 12% interest.

I tried an alternative that delayed paying the 624000 as long as possible to maximize the interest advantage. However, this still took thirty-six months. It might have produced a small advantage over just paying the 95000, but not much of one.

Borrowing 600000 and paying off 695000 of the larger loan in the first month is the most effective. Then pay 95000 a month on the larger loan, except every twelfth month pay 71000 on the larger loan and the 24000 interest on the flat-rate loan. Take out a new flat-rate loan to pay off the principal on the old one. That's the most effective. It reduces you from thirty-six payments to thirty-five. You pay 72000 in interest on the three 600000 loans and 287427 interest on the 3000000 loan.

In summary, you can pay off the loan in thirty-six months by paying 95000 every month. You can cut one month off that by taking out a 600000 loan in the first month and waiting as long as possible to pay it back. To repay the flat-rate loan, you take out a new one every twelve months. Once the large loan is paid off (after twenty-eight months), pay off the flat-rate loan. That will take seven months.

Note that if they refuse to extend a new loan to you to replace the old one, there's nothing that you can do in that case. You'd have to take the consequences of defaulting on payment of the loan, which might be worse than the original loan. Of course, perhaps you can get them to loan you the same amount for three years at 12%.

I'll leave it up to you if cutting a month off the repayment period is worth enough to justify the headache of the flat-rate loan.

The limited savings primarily caused by the flat-rate weirdness. The 4% rate is comparable to an 8% APR the way that the other loan is calculated. And that's only if you wait as long as possible to pay it back. The quicker you pay it, the less advantage there is from the flat rate. That's why you should pay off the flat-rate loan last if you get it.