| Part prepayments reduce not only the term of the loan but also the total interest payable |
Home loans are for the long term and as such, banks and Home Finance Companies (HFCs) normally offer repayment tenure up to 240 months (20 years). Some banks offer tenure up to 300 months (25 years) also. For salaried class applicants, normally repayment tenure is offered up the age of retirement and for self-employed applicants, the tenure offered would be up to the age of 65.
When home loans are provided jointly for husband and wife, father and son, normally the tenure offered would be up to the retirement of elder applicant, if salaried, or up to 65 years, if self-employed.
Let us analyse the pros and cons of long term vis-à-vis short-term repayment tenures.
The longer the repayment tenure, the higher is the loan eligibility. Let us assume that the applicant's income is Rs. 45,000 per month and the credit norm of the lender allows EMIs to be 40 per cent of the applicant's income. The applicant would be eligible for a loan of Rs. 8.67 lakh at nine per cent interest, if he chooses short-term repayment of five years. He would be eligible for Rs. 20 lakh at nine per cent interest, if he chooses a 20-year tenure
The longer the tenure, the lesser is the repayment instalment (EMI). For a loan of Rs. 20 lakh at nine per cent interest, the EMI for five years would be Rs. 41,517 and for 20 years' tenure, the EMI would be Rs. 17,995
The interest payable over the longer tenure would be very much high as compared to the shorter tenure. The interest payable over 20 years would be Rs. 23,28,450 approximately and for five years, the interest payable would be just Rs. 491,000 approximately.
Another disadvantage of long-term loan is that in the initial years of repayment, the principal loan amount repaid is very much less as compared to short/medium-term loans. For example, in the 25-year tenure, the loan repaid for the first three years is Rs. 22,314, 24,407 and Rs. 26,696 respectively. In the case of 10-year tenure, the loan repaid for the first three years is Rs. 1,29,278, 1,41,406 and 1,54,670 respectively.
Balancing act
Suppose the applicant is 35 years old and opts for a 25-year tenure, not only he will pay total interest of Rs. 30,35,118, he would be paying EMIs throughout his service. If he chooses the short term, he may not be eligible for the required loan amount as property costs are still very high.
Since interest rates have come down from 12-13 to 8-9 per cent, it is likely that interest rates would go up in future. In such a case, suppose the borrower has opted for a shorter tenure, the lender may allow him to extend the tenure. If he has opted for the longer tenure, he would be in for more hardships, as increased EMIs may become a burden or repayment may even extend beyond his retirement year and as such he would be in a life-long debt trap.
The balancing act is tough and you need to do proper home work and choose the right tenure.
In the U.S., since interest rates are very low (3-5 per cent), 30 years repayment is viable. But in India, where historically interest rates are higher (10-12 per cent), long-term loans are not advisable.
As can be seen from chart 1, the loan eligibility is very less for short-term schemes. Hence, for most of us, it becomes mandatory to choose longer periods ranging from 15 to 20 years.
After choosing the long-term tenure, you need to plan for lump sum part prepayments, as most banks and HFCs allow you to make part prepayment 3-4 times in a year without any penalty. Since part prepayments are apportioned towards principal outstanding, the loan tenure gets reduced. Thus, part prepayments not only reduce the term, the total interest payable also comes down considerably and the best part is that you will be getting rid of the loan much earlier. If you can prepay lump sum equal to 4-5 EMIs in a year, the loan tenure reduces to 10-11 years from 20 years.
by R.P. DESHPANDE The author is the Director of Institute of Home Finance and can be contacted at deshpanderp2007@gmail.com
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