Reduce tenure, not EMI, when home loan rates dip

Home loan borrowers would now be heaving a sigh of relief. After over three years, home loan rates are beginning to come down as the Reserve Bank of India has brought down benchmark rates and has been persuading banks to do so.

In the last five-six months, all major banks such as State Bank of India, ICICI Bank and HDFC Bank have cut their prime lending rates and, consequently, home loan rates.

As a result, many borrowers now have the option of either reducing their equated monthly instalments or their loan tenure.

Reduced EMIs may be very appealing to borrowers because of a lesser burden on a monthly basis, but there is a catch to it. If the tenure remains unchanged, there is a higher interest outgo. An example should make this clear.

If you have taken a loan of Rs 50 lakh (Rs 5 million) at 10 per cent interest for 15 years, the EMI would be Rs 53,730. Now, say, the interest rate falls to 8 per cent at the end of the third year. The bank gives you an option to either reduce the EMI or the tenure.

Here's how your options work out: With an outstanding principal of almost Rs 45 lakh (Rs 4.5 million) at 8 per cent for 12 years, the revised EMI would be Rs 48,667 -- a reduction by Rs 5,063 per month.

But continuing with an EMI of Rs 53,730 would lead to winding up of the loan in 123 months (10 years and 3 months). That is, a saving of interest payment of 21 months (12 years = 144 months). The saving is a huge Rs 4.10 lakh (approximately).

This is the reason why financial planners say that reducing the tenure should be of prime importance. "One should always look at the lowest tenure possible and then take a call on the EMI," said Gaurav Mashruwala, a certified financial planner.

According to him, even if tax deductions were good, a big loan could always hurt because of unpredictable interest rate movements.