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Changing interests that influence your repaymentsR. 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 50-

55 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 discountedinterest rate.

Let us analyse what happens when the interest rate charged on home loan is increased ordecreased. 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) andthe 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 prepaymentamount.

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. 11per cent) after two years of repayment, the EMI increases to Rs. 25,699.

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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 theloan. 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 goesbeyond 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 interestpaid 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 yearsand 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 haveeven allowed repayment tenure to go much beyond retirement age (even up to 80-85 years ofborrowers), which is a dangerous trend. Such a move will virtually not only make the debt life-

long burden, the interest payment would be 2-3 times of loan amount availed.

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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)