Source: The Economic Times
So you are all set to buy your dream home? May be you are already arranging for the down payment and preparing to make that biggest and, perhaps, the best investment of your life. While taking a home loan, the normal tendency is to stretch the loan tenure to the maximum. Some banks actually offer loans with a 25-year tenure to reduce your EMI (equated monthly instalments) payments. With rising property prices, this strategy is becoming quite popular for property buyers. But is it prudent to go for such a long-tenured loan?
While it is true that you can pay only as much as you can afford, the key question is to what extent should you extend the tenure. Though you reduce your EMI payments by extending the loan tenure, you also end up increasing the interest payments. So, what is the optimal tenure that you should go for - 15 years, 20 years or 25 years? Our number-crunching finds that it is prudent to not extend loan tenures beyond 15 years.
First let's decode the EMI and find out how its components affect you. EMI comprises two parts - principal and interest. So, every time you pay an EMI, some of it goes towards paying the loan amount (and reduces it), while the balance goes towards paying interest for the loan. At the beginning of the tenure, the interest component of the EMI is the highest and as you pay EMIs, the principal amount that you have to return gets reduced. Consequently , the interest on this remaining loan also keeps reducing. Since for you the outflow (EMI) is the same, you do not understand the impact, but as you proceed, the principal repayment gets faster and the interest component of the EMI reduces.
If you take a one-year loan of Rs 1,000 loan at an interest rate of 12%, your EMI comes to Rs 89 (see table 'Home On The Range'). But if you look closely at the components, you'll find that in the first month, you will pay Rs 10 as interest and Rs 79 as principal. So, in the following month, your loan outstanding reduces to Rs 921. In the subsequent EMI, you pay Rs 9.2 as interest and Rs 80 as principal. Thus, by the end of the tenure, Rs 88 of the EMI go towards repaying the principal and the interest payment hardly amounts to anything.
The faster you reduce the principal outstanding, the better it is, as you will be paying lesser interest. Let's see what will be the repayments for a Rs 1,00,000-loan for different time periods (15, 20 and 25 years), assuming an annual interest rate of 10% (see table 'What's The Difference'). As you can see, the interest component varies significantly over the three time frames. For a 15-year loan, the EMI works out to Rs 1,075 for a loan amount of Rs 1 lakh. Instead of 15 years, if you go for a 20-year loan, you will end up paying Rs 38,176 more in interest, compared to a 15-year loan. In the process, you also reduce your EMI per lakh by Rs 110. For a Rs 30-lakh loan, it means reducing your EMI by Rs 3,300.
For a 25-year loan you Rs 41,005 more in interest, compared to a 20-year loan for a Rs 1-lakh loan and a staggering Rs 79,181 (38,176+41,005) more in interest compared to a 15-year loan. So, you reduce your EMI compared to a 15-year loan - Rs 56 per lakh. For a Rs-30 lakh loan, it means reducing the EMI by Rs 1,680. So, while you saved Rs 3,300 on your Rs 30-lakh loan by moving from a tenure of 15 years to 20 years, you saved only Rs 1,680 by moving from 20 years to 25 years.
Post a Comment