Home Loans have been a game changer for home buyers.
Had it not been for the easy availability of these loans, it would not have been possible for most people to purchase a home in first place. It’s another matter that easy availability of loans is one of the reasons why property prices have become unreasonably high.
But let’s focus on the issue at hand.
Home loan tenors.
Can a shorter home loan tenor save you money? On what factors should you base your decision to chose the home loan tenor?
For the sake of discussion, let’s take a small example: Suppose you wish to take a home loan of Rs 50 lac. The loan is available at 9.5%. Now theoretically, you have the option to chose a tenor between 10 and 30 years.
Let’s see what happens to the EMI and the total interest paid over various tenors:
I am sure there are few things that have already caught your eye. 🙂
As you can see, shorter the tenor, higher is the EMI. That’s easy. Obviously, the loan gets repaid faster too.
But more important is that shorter the tenor, lesser is the absolute interest cost. And by substantial numbers!
Just compare the rows of 20- and 30-year tenors.
For just a few thousand more (in EMI), you end up saving about Rs 35-40 lac in total interest payment and 10 years in tenor.
Not bad. Right?
And have a look at the last column. It reinforces the idea of having a loan with the shorter tenor.
Let’s take another scenario: You plan to take a property loan of Rs 30 lac. The loan is available at 9.0%. Once again, you have the option to chose a tenor between 10 and 30 years.
Here is the table with answers:
If you are planning for a 30-year loan with EMI of about 24K, just remember that by paying just a few thousand more (around 30K), you will half your tenor to 15 years and also save tons of money on interest (down from Rs 57 lacs to Rs 25 lacs).
This is no magic. And banks are not fooling you.
This is plain maths at play. Don’t be under the impression that a shorter loan is cheaper than a longer one. Both cost the same (9-10% or whatever is your home loan rate). It is just that you are paying the x% interest for a longer duration in the longer-tenor loan.
So the gist of this analysis is that as the loan tenor increases, you need to pay a lot more towards interest cost.
Lenders (banks and NBFCs) won’t tell you this angle because of various reasons – mainly being that they earn more from borrowers if the tenor is longer. 🙂
But to be fair, there are other factors at play too when it comes to deciding home loan tenor.
The biggest factor is EMI Affordability. That too at two levels:
- EMI Affordability: As seen by the borrower
- EMI Affordability: As seen by the lender
Let’s deliberate on each of these in a bit detail.
EMI Affordability: As seen by the lender
Lenders are in the business of lending. More often than not, they know whom to lend, how much to lend, etc. (ignore big corporate NPAs for this discussion please).
In order to safeguard their interests when lending money to home loan borrowers, the lenders adhere to certain guidelines. And according to these guidelines, the lenders ensure that sum of EMIs of all the loans (home, auto, personal, etc.) does not exceed more than 40-45% of the borrower’s monthly income. So if your monthly income is Rs 1 lac, you will only get loans until the time your total EMIs are around Rs 40,000.
So that is one limit that is put by the lender on home loan borrowers too. If your income is Rs 80,000, then at most you can expect a loan that has an EMI of Rs 32,000. That too if you don’t have any other loans and have a good credit score.
Now different loan-tenor combinations are possible with an EMI of Rs 32,000:
- Rs 25 lac loan for 10 year tenure = EMI of 31,669
- Rs 30 lac loan for 14 year tenure = EMI of 31,468
- Rs 35 lac loan for 19 year tenure = EMI of 32,091
- Rs 40 lac loan for 30 year tenure = EMI of 32,185
So for the same EMI eligibility (as per lender’s 40% rule), you can have various loan amounts and tenors.
It depends on how much money you need. So if you need Rs 40 lac as loan and earn Rs 80K a month, then you will have to take a loan of 30-year tenor so that EMI remains within the scope of 40%-lender’s limit.
That’s even if you know that going for a long-term loan means losing out on lacs of rupees on interest paid. This is another reason why you shouldn’t over borrow. Only borrow what is necessary.
Lenders might not even give you the option to chose. But you can always prepay and get over with the loan when you want. Isn’t it?
EMI Affordability: As seen by the borrower
You are earning Rs 80,000 a month and lenders are willing to give you a loan of Rs 35 lac with 20-year tenor. As the EMI would be about ~ Rs 31,500 and within the limit of 40%. But you know (and lenders don’t) that in a few years time, you have to contribute towards your sister’s wedding. So you cannot just be paying loan EMIs. You need to save for her wedding too.
So even though the bank is ready to give you a loan with EMI of Rs 31,500, the fact of the matter is that it’s not affordable for you due to other personal requirements.
Now you have two options:
- Reduce your loan requirement (not easy)
- Increase your tenor (possible if lender agrees)
This is what EMI affordability from borrower’s perspective means.
But on the other hand, if you recently got married with your+spouse’s income almost doubling, then you can easily pay more every month to close the loan as quickly as possible. You don’t need to keep paying ‘only’ the bank specified EMI just because you have been told to do so. You should pay more if it’s comfortably possible for you!
Three more points before I end.
- In an effort to close the loan as early as possible, do not neglect saving for other financial goals. You need to have balance between paying EMIs, saving for short term goals and investing for long term goals.
- I have not discussed the tax angle here. A lot of people want to continue the loans because of the tax benefits. I feel it’s a bit overrated given the fact that you can save a lot more by closing the loan early. I will discuss this angle in detail in another post.
- If you are confused and have doubt about your future repayment ability (even after considering your salary hikes), it’s better to go for longer tenor. It will give you flexibility and peace of mind. You can always prepay (when you want) even when you have a long tenor.
Note – If you are yet to buy a house using a loan, don’t go overboard if home loan rates are falling and property prices are down. Always assess your individual financial situation whether to go for a loan-funded property purchase or not.
I hope I was able to highlight the importance of having a shorter home loan tenor. The choice of home loan tenor does have a big impact on total interest paid to the banks/lenders.
So when you are planning to take a home loan, first of all make sure that the EMI is affordable, not just today but also tomorrow. Also remember that you need to save & invest for other financial goals. You cannot postpone everything till you clear your home loan. It might not work. And most importantly, try to reduce your loan tenor to the minimum you can comfortably manage. It means paying higher EMIs but that is fine. It will help you save a lot of money on the interest costs.
good one. Another thing I think needs mention is that if one wants to prepay he should do it during the early part of the month ( say between 1st to 5th of the month) . This will help reduce his interest burden
Dear Dev Ashish Ji,
Very good article …. One more thing I wish to add that you (Home loan borrower) start the SIP 0.1% of your loan amount for the same tenure and your interest burden will be compensate.
For Example..If we borrow a loan of 20 Lacs for 20 years then we should start 2000 SIP for 20 years and the interest we shall pay in 20 years will be backed by your SIP Investment 🙂
That looks like a good and easy-to-implement suggestion. Thanks for sharing your idea. 🙂
I think the article is flawed.
Generally people take loans because
1) No upfront cash available
2) Benefits on let out property was immense earlier (no limit on taxable income for interest)
Affordability of high EMIs may not be everybodys cup of tea.
Yes it shows that shorter the tenure, lower the interest outgo, but consider this
Keep the tenure longer so there is lesser outgo initially. Once you get sufficient footing based
on accrued income from sources such as shares or FDs meturing or even company bonus, pay off
the lumpsum towards principle.
I have already highlighted that affordability of EMI is the key decision maker. 🙂
Article is good. I think you may want to say “tenure” instead of “tenor”.
I have been reading your articles over last month or so. Many of them are very informative and give very good perspective about investment for lay man. But something about this articles made me think more. I did some rough calculations on loan tenures. For loan of Rs 50L @ 10%pa, I would pay EMI of Rs 45,435 over 25 years or Rs 53,730 over 15 years. Assuming I opt for 25 years tenure and SIP difference in EMI (Rs 8,295) into mutual funds . After 15 years, I will be able to pay off loan balance of Rs. 34,38,122 with returns from MF with little over 10%pa. And if lucky, with higher returns from MF, I would have some money left. Eg, @12%pa I would be left with ~5L extra. You thoughts!
Without getting into the mathematics, I can say that there will always be multiple ways to optimize financial decisions. But when it comes to loans, one also needs to pay attention to the non-financial angle that many people look at – ‘getting over with the damn loan’. 🙂
I am sure that the scenario that you have suggested would work given the interest/return differential between home loans and MF returns. Will try to do a post on the same. But having said that, the person should have the discipline of investing the difference (15yr EMI – 25yr EMI) for a long time.
But like many others have pointed out, if the part of the money you don’t pay (by opting for lower EMIs) can earn returns (elsewhere) higher than the interest rate on the loan, it makes sense to opt for lower EMIs.
But I think your premise is that if you can stretch a bit (on your Email) you must. Which I totally agree with.
Perhaps you could also add a bit on prepayments of loans. Say, if a borrower were to pay, say, 10K more than his EMI for a year. How much will it reduce the total outgo by!