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EMIs on home loans rise



Do not prolong the loan:It is better not to raise the loan term when confronted with higher EMIs.

In a high inflationary economy, the interest rates regularly move up, giving home loan borrowers the shivers. The equated monthly instalments (EMIs), comprising up to 50-55 per cent of the earnings of a family, are steadily going up, making family finances go haywire.

The interest rates which were hovering around eight per cent two years ago have almost touched 10 per cent, making EMIs increase significantly. If one has opted for ‘teaser loans,' the effective hike in interest rates would be much higher, after the initial period of discounted interest rates.

Let us analyse what happens when interest rate charged on home loan is increased or decreased. If a loan were obtained at fixed rates, there would be no change in the EMIs throughout the loan tenure. Since home loan repayments stretch up to 20-25 years, lenders normally push variable (floating) interest rate schemes or at the maximum, offer fixed rate for a term of say five years. Hence, more than 90 per cent of existing home loans are at variable interest rate schemes.

Mr. Anand has a home loan of Rs.25 lakh at 10 per cent for a tenure of 20 years (240 months) and the EMI is Rs. 24,126. If after two years, the interest rate were reduced to nine per cent, then the EMI works out to Rs.22,596 for the balance 18 years tenure.

In such a case, since post-dated cheques (or standing instructions/electronic clearance system mandate) are taken in advance for EMIs of Rs.24,126, normally the lender will continue to collect the old EMIs. The difference between the old EMI and new EMI (Rs.24,126 - Rs.22,596 = Rs.1,530) would be adjusted towards extra loan recovery (principal amount) or prepayment amount.

In the same illustration of Mr. Anand, if interest rate were to go up gone by 1 percentage point to 11 per cent after two years of repayment, the EMI increases to Rs.25,699.

In case, the borrower continues to pay old EMIs, the shortfall in the EMI (Rs.25,699 – Rs.24,216 = Rs.1,573) is practically considered short collection in the principal amount of the loan. This will increase the repayment term to 296 months (24 years and 8 months).

When interest rates go up marginally, normally lenders may continue to collect old EMIs. If interest rate increases more than 2 per cent or the increased repayment tenure goes beyond the retirement age of borrower, the lender will force the borrower to pay higher EMIs by collecting fresh post-dated cheques/ECS mandate with increased EMIs. Another issue would be that even the interest portion may not be covered in old EMIs and hence, lenders will have to seek revised EMIs from the borrowers.

When the interest rate comes down, it is advisable to continue to pay old EMIs as the loan tenure gets reduced. In the above illustration, if old EMIs are paid, then loan gets repaid in 210 months, instead of 240 months. In other words, the borrower not only gets rid of a long-term loan much earlier, the total interest paid on the loan also decreases from Rs.32,89,800 to Rs.25,55,950, a savings of Rs.7,33,850.

When interest rate goes up, it is advisable to arrange to pay higher EMIs, even if it is a bit burdensome, otherwise the debt becomes a life-long affair.

In the above illustration, where only 1 per cent interest has gone up, the repayment term increases to 296 months (24 years and eight months). If interest rate goes up by 1.5 per cent (11.5 per cent), the tenure increases to 357 months — 29 years, nine months. For a loan of Rs.25 lakh, the borrower ends up paying total interest of Rs.61.25 lakh.

In the present scene of increasing interest rates, some new generation banks have even allowed repayment tenure to go much beyond retirement age (even up to 80-85 years of borrowers), which is a dangerous trend.

Such a move will not only make the debt a life-long burden but also make the interest payment two to three times of the loan amount availed.

R.P. DESHPANDE

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