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.
| Repayment Options | Total Interest Paid | Interest Savings | No of Instalments Loan Gets over in | No of Instalments Saved
|
| When Original Loan is kept for 20 Years | 3478026
| 0
| 240
| 0
|
| When EMI is increased by 5% every year | 2192086
| 1285940 (37%) | 145
| 95
|
| When EMI is increased by 10% every year | 1762469
| 1715556 (49%) | 113
| 127
|
| When 10 Lakhs Prepayment is made and EMI is kept constant at 26991.78 | 1047781
| 2430245 (70%) | 113
| 127
|
| When 10 Lakhs Prepayment is made and EMI is reduced to Rs 17911 | 2353215
| 1124811 (32%) | 240
| 0
|
| When EMI is increased for 1st 7 years till EMI reaches 36,172 and then kept constant | 2277489
| 1200537 (34%) | 157
| 83
|
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 10th 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.
