Home Loan EMI

Team CrawFin/ Harshal Jawale, CFP^CM

In my last article I wrote about saving rate deregulation, although it is a bonanza for us depositors, it would also mean high cost of funds for banks resulting into higher EMI’s for loan takers. I had a chance to speak to few worried home loan takers who are facing skyrocketed EMI these days. Obvious question was how much is the increase in EMI is expected and how to bring it down?

Even though there is no choice we have than to pay interest i.e. cost of fund we raised to acquire asset, I felt they were quite unimpressed with the ideology of paying principal upfront to reduce interest burden for future years. Reducing interest rate somehow was predetermined approach they had in mind. In this article I will try to cover similar points with the help of simple calculations to show which option reduces how much amount to be paid.

For simplicity of calculations I will take INR 15Lkh as the current balance Loan amount with interest rate at 14% for 10 years tenure.

	Existing case	Case A – Int rate reduced by 1%	Case B – Pre payment of INR 1Lakh	Case C – Pre pay 1Lakh but keep EMI
Loan Amount	INR 15,00,000	INR 15,00,000	INR 14,00,000	INR 14,00,000
Interest Rate	14%	13%	14%	13%
Tenure	10 years	10 years	10 years	98 months
EMI	23,290	22,397	21,737	23,290
Total Amount Paid	27,94,796	26,87,593	26,08,476	22,76,644
Interest Component	12,94,796	11,87,593	12,08,476	8,76,644
Total Saving	--NA--	1,07,203	1,86,320	5,18,152

Case A – Reducing Interest rate by 1%

You may jump from one lender to another; a chance of reducing interest rate more than 1% in current tight liquidity scenario is not possible. As we can see in table your EMI is reduced to 22397 from 23290 for the same tenure of 10 years. Total saving of 1.07Lkh Approx.

Case B – Pre-Paying INR 1Lkah keeping interest rate same

Pre-paying 1Lakh to current lender will reduce your EMI to 21737 from 23290 with total saving of 1.86Lakh. Please note here we are considering pre-payment of INR 1lakh only once (not yearly).

Case C – Pre-pay 1lakh but keep EMI constant

Assuming we have another lender who is offering 1% less than current lender then why not switch? But still pre-pay principal and keep EMI constant for multifold benefits. Such setup will reduce tenure to 98 months; it will save about 5.18Lakh in total.

As we can see reducing interest rate or pre-paying only once does not reduce our monthly outgo substantially in terms of EMI. Both of them together but keeping EMI constant will reduce total cost of loan by sizeable amount. Most often we try to reduce interest rate with negotiations or pre-pay loan amount somehow but conveniently forget to keep EMI constant, reduced EMI serve no benefit in the longer run.

People make new investments into FD, PF, MF, Shares every year instead of serving home loan with immediate effect. I wonder how 8.5% returns of PF compensate for 14% interest charged on home loan. There is more to retirement than just PF. Asset that you are acquiring from home loan is worth several crore when you retire, mere reverse mortgage or keeping it on rent and shifting to smaller flat will solve your retirement problems.

Why go that far, when you can save substantial amount saved on interest cost (with case C) if invested into PF after serving loan will create large retirement corpus by the time you retire. Also some people think prepayment amount needs to be higher to make any noticeable effect. Please come out of box thinking and pre-pay whatever small cash surplus you have by year end, which will still take compounding effect to your cost of loan.

Tip – In above example if you continue to pre-pay INR 1lkah every year keeping EMI constant then you would close your home loan within 6 years.

Wealthy investment needs healthy methods!!!