Should you increase EMIs or tenure of loan?

Planning to retire early? Think again, if you have long-term liabilities in terms of a 15-20 year mortgage on your home.

For, under the current rising rates scenario, a 30-year-old borrower who has taken a 20-year loan that he expects to repay by the time he reaches 50 could very well be shelling out EMIs till he turns 73.

This is because, a 150 basis points hike interest rates could expand the tenure of a 20-year loan into 30 years, says Crisil in its latest study on mortgage.

This is clearly not a viable option especially for long tenure loans, the rating agency says. Today, about 28 per cent of outstanding home loans are of 16-20 year maturity.

Pension tension Impact of rising interest rates on:
Tenure New tenure, in years
Original loan	Interest rate raise, basis points
tenure, years	50	100	150	200
5	5.1	5.1	5.2	5.3
10	10.3	10.7	11.1	11.6
12	12.5	13.1	13.8	14.7
15	15.9	17.1	18.5	20.3
16	17.1	18.5	20.2	22.7
17	18.3	19.9	22.2	25.6
18	19.5	21.5	24.4	29.2
19	20.8	23.2	26.9	34.2
20	22	25	29.8	42.9

Monthly installment Percentage rise in monthly instalment
Original loan	Interest rate raise, basis points
tenure, years	50	100	150	200
5	1.2	2.4	3.6	4.8
10	2.2	4.5	6.7	9
12	2.6	5.2	7.8	10.5
15	3.1	6.2	9.4	12.6
16	3.2	6.5	9.9	13.3
17	3.4	6.9	10.4	13.9
18	3.5	7.2	10.8	14.5
19	3.7	7.4	11.3	15.1
20	3.8	7.7	11.7	15.7
Note: Original loan at 7.5 per cent floating rate; It's assumed that interest rates are revised immediately and sustain the rise through the entire tenure of the loan. Source: Crisil

If the interest rate on a 7.5 per cent variable mortgage loan move upwards by 200 basis points, the monthly installment payable by the borrower would shoot up by 16 per cent.

This means a borrower contributing 50 per cent of his income towards the mortgage on his home would end up shelling out 58 per cent every month during his working years.

But this is clearly a better option than having to shell out funds from one's pension package -- as it would be in the first example -- which obviously tends to be far smaller than one's pay package.

If housing finance firms do not hike the EMIs, it could in the later years result in defaults. However, the option of increasing the EMI is only feasible for those whose instalment as a proportion of their income is low.

According to Crisil, about 15 per cent of borrowers pay an EMI which is more than 50 per cent of their income. The average age of a home loan borrower in the country today is 35-40 years.

This limits the ability of the lenders to increase the tenure significantly, and pushes the case of increasing the EMI instead.

The best solution would be a mix of the two -- increasing the tenure and instalment on a customised basis.

A small increase of 50-100 basis points in interest rates could lead to only a marginal rise in the tenure of mortgages, and can be easily borne by the borrowers.

However, a rise of 150-200 basis points in interest rates would lead to a quantum jump in the tenure of the loans. That's a predicament neither the lender nor the borrower would like to be in!