Home loan come with uncertainty about interest rates and repayment

Home loan is attached with uncertainty about interest rates and repayment. Harsh Roongta explains some options.

The first thing is with interest rates rising on your home loans, what should you do? Pay a higher EMI or increase the tenure of your loan?

In May 2005, Ratan Shetty, who works with an IT company, took a home loan of Rs 10.5 lakh at an interest rate of 7 per cent for tenure of 20 years. At that time, he was paying an EMI of Rs 7,443. In just two years, the interest on his home loan has risen to 11.25 per cent, and his EMI has increased to Rs 10,453, a rise of more than Rs 3,000 per month.

Which option is the best? This all will depend on your age, your overall financial situation and the future course of interest rates. Here are some advantages and disadvantages of each choice.

Lets look at the first option should you pay high EMI


If you have taken a Rs 10 lakh loan for a 10-year term, half a percentage increase in interest rates will increase your EMI by around Rs 290. If you know that the interest rate will increase in the near future, increasing your EMI may be the best option because you have the advantage of not prolonging your loan period at higher rates. This will also help you in getting tax breaks on your increased interest outgoings.

The disadvantage in this option is the pressure that the higher EMI puts on your monthly budget. You have to make adjustments in your budget. You may have to sacrifice some aspect of your lifestyle or reduce your financial investments. If you are financially overstrained now, it may be better to keep the same EMI and lengthen the tenure.

Increasing the tenure of the loan, if interest rates fall in the future then you will benefit from this strategy; the opposite holds if interest rates rise. In a rising interest rate regime, increasing the tenure of the loan will increase the cost of your home.

If your age is 60 years or 65 then the bank will not extend tenure beyond retirement age. Therefore this option may not be available if you are close to retirement. Another problem is that some banks put a limit on the maximum tenure and it may not be possible to increase it beyond 20 or 25 years.

If you have enough of finance with you and can pay a lump sum this will reduce your outstanding balance so that your EMI doesn’t rise even after taking into account the higher interest rates.

For example, assuming you have a Rs 15-lakh loan for a 20-year term at an interest rate of 12%, your indicative EMI would be around Rs 16,517. If the interest rate inches up to 13%, you would have to pre-pay around Rs 90,000 to retain the same EMI and tenure.

It might be difficult to raise that kind of cash since you have already stretched yourself to buy that dream home. In that case, you may have to settle some of your investments or pledge financial assets such as an insurance policy or national savings certificate and receive an overdraft facility that will allow you to make the pre-payment.
Before choosing pre-pay loan option, check if there is any penalty for the partial pre-payment of your loan. Take into account the loss of tax benefits because your tax-deductible interest payments are lower after pre-payment.