Home Loan Repayment Options

Tarun is a young professional working in a MNC. Tarun recently got married and he has bought a new flat. He has taken a home loan of Rs 30 Lakhs for 20 years and is paying an Equated Monthly Installment (EMI) of Rs 26,992.

Consequences of Interest Rate Hike
Tarun is a worried man nowadays. He has heard of all the talks of a rate hike doing the rounds in the market. If that happens his EMI on the home loan will go up.

Tarun is worried that if interest rates go up too much and too fast it might increase his EMI significantly. If the interest rate on the loan goes up Tarun can increase the EMI and keep the tenure of the loan same OR increase the tenure of the loan beyond 20 years and keep the EMI same. Not many banks will allow extension of the loan beyond 20 years. In that case the bank will have no option but to increase the EMI on the home loan. If the home loan EMI goes up much more significantly than expected it can affect Tarun’s cash flows. Tarun will have to divert his cash flows reserved for other activities like children’s education and marriage, retirement fund; towards servicing the home loan EMI. Such a situation can have a negative effect on Tarun’s entire financial planning. Like Tarun, lot of people face this situation when interest rates rise rapidly and they are caught unaware. As they don’t anticipate this sudden rise in the EMI; they don’t have a backup plan ready to face this type of situation.

Home Loan Repayment Options
So how can people like Tarun plan the repayment of their home loans so that it gets over before the scheduled time? Banks offer various repayment options apart from the normal regular EMI repayment option.
Let us see how the use of different re-payment options will affect Tarun’s loan tenure and interest savings on the home loan.

Let us take a look at each of the above options available to Tarun to repay the home loan in more detail.

1) Step-Up EMI by 5%
Under this repayment option the customer can increase his EMI every year by a certain percentage. An employee expects his salary to increase by an average 10% or so every year. With the increase in salary he will have additional resources at his disposal. He can use this monthly additional cash inflow to increase his EMI every year so that he can clear the loan before the original scheduled date.

Tenure Gets Reduced: If Tarun goes on increasing his EMI by 5% compounded every year, then his 20 year (240 payments) home loan will get over in 12 years (145 payments). So number of instalments will get reduced by 95 (240 – 145).

Interest Savings: On the original loan of 20 years Tarun would have paid an total interest of Rs 34,78,026. But if the EMI is increased by 5% compounded every year then the total interest paid on the loan will be Rs 21,92,086.73. This will result in interest savings of Rs 12,85,940.15 (37%) for Tarun.

2) Step-Up EMI by 10%
Tenure Gets Reduced: If Tarun goes on increasing his EMI by 10% compounded every year, then his 20 year (240 payments) home loan will get over in the 10^th year (113 payments). So number of instalments will get reduced by 127 (240 – 113).
Interest Savings: On the original loan of 20 years Tarun would have paid an total interest of Rs 34,78,026. But if the EMI is increased by 10% compounded every year then the total interest paid on the loan will be Rs17,62,469.91. This will result in interest savings of Rs 17,15,556.97 (49%) for Tarun. Please note that here in this case the overall interest paid on the loan will almost get reduced to half of the original interest amount.

Conclusion
Let us quickly summarise the different re-payment options for Tarun and how these options will affect the loan tenure and interest savings on the home loan.

After seeing the benefits of various home loan re-payment options the customer should keep in mind the below mentioned important points before deciding on the home loan repayment options:
When the customer goes for increase in EMI or partial pre-payment or a combination of both, he should make sure that he is not diverting the money reserved for his other important financial goals like children’s education or marriage, retirement corpus. If the money for other goals gets diverted towards home loan repayment the other financial goals will suffer. So the customer should analyse his cash flows carefully and then take a decision accordingly.
Also when the customer goes for increase in EMI by say 5% or 10% every year he should make sure that he will be able to service the EMI. If the customer stretches himself just to finish the home loan in the earliest possible time he may face cash flow problems.
For example if the customer goes for increase in EMI by say 10% compounded every year; then after few initial years the EMI may reach a substantial amount and it may become difficult for the customer to service such a huge EMI.
Also in case of floating loans the interest rate on the home loan keeps getting revised with the movement in the Bank PLR. So once the interest rate changes all the calculations will change.
If you would also like to restructure your home loan and save on interest then you can get in touch with us at gopal_gidwani@yahoo.com

Please do let us know your comments on the article at gopal_gidwani@yahoo.com

For people who are looking for a Home Loan and want to compare the Home Loan Schemes of different banks can refer this article: Home Loans Rates Comparison

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