Changing interests that influence your repayments

R. P. DESHPANDE What happens to the monthly budget of a home buyer when the interest rate charged on home loan is increased or decreased? An analysis by our finance expert R. P. Deshpande In a high inflationary economy, obviously interest rates are regularly moving up, giving home loan borrowers the shivers. The repayment schedules i.e. the equated monthly instalments (EMIs) that are normally the single largest outgoing in the monthly budget, comprising up to 5055 per cent of earnings, 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 to 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 rate. Let us analyse what happens when the interest rate charged on home loan is increased or decreased. If 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. go for the calculator: It is important to be aware of the ever-changing interest rate on home loans so that you understand the rise and fall in your equated monthly payments When interest rate comes down 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 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. When interest rate increases In the same illustration of Mr. Anand, if interest rate were to go up gone by one per cent (i.e. 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 as 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 by marginally, normally lenders may continue to collect old EMIs. If the interest rate increases by more than two 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. Revised 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 long-term loan much earlier, the total interest paid on the loan also decreases from Rs. 32,89,800 (apx.) to Rs. 25,55,950 (apx.), a saving of Rs. 733,850.

Wise thing to do When interest rate goes up, it is advisable to arrange to pay higher EMIs, even it is a bit burdensome, otherwise the debt becomes a life-long affair. In the above illustration, where the interest has gone up by only one per cent, the repayment term increases to 296 months (24 years and 8 months). If the interest rate goes up by 1.5 per cent (11.5 per cent), the tenure increases to 357 months, i.e. 29 years, 9 months! For a loan of Rs. 25 lakh, the borrower ends up paying total interest of Rs. 61.25 lakh! In the present scenario 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 virtually not only make the debt lifelong burden, the interest payment would be 2-3 times of loan amount availed.

If you are facing a similar situation, take the issue seriously and contact your lender to get the EMIs increased and issue revised post-dated cheques/ECS mandate. (The author is a Director of Institute of Home Finance and can be contacted at deshpanderp2007@gmail.com)