Recently, there has been a massive impact in the home loan Easy Monthly Instalments (EMI’s) due to interest rate changes in India. Either the EMI’s have increased or the tenure for home buyers.
How did this happen? Let us understand it through an example –
Let’s say, a year back, Karan took a home loan of ₹ 1 Crore at 8.50% for 20 years. The monthly EMI was ₹ 86,782.
Before we proceed further, let us understanhod the concept of home loans and EMI’s in detail.
Every loan and the corresponding EMI payments have two components:
- Interest servicing portion – this is the interest cost to the lender for financing the loan.
- Principal repayment portion – which reduces the principal outstanding.
Proportion of interest servicing and principal repayment depends on various factors such as tenure of loan, rate of interest, part payments and number of EMI’s already paid.
In the below table, we have analysed the EMI composition for 1st month and 13th month for different tenure of 10, 15, 20, 25 and 30 years.
Few noteworthy things from above table:
- Shorter the tenure, higher is the principal component in the EMI.
- As time progresses, the proportion of principal components keeps increasing in the EMI and proportion of interest servicing keeps decreasing.
Let us revert back to our example. Karan paid the first 12 EMIs of ₹ 86,782. There was no change in rate of interest in the first 12 months.
For the sake of simplicity, let’s assume, suddenly, the rate of interest, after paying the first 12 EMIs at 8.50%, is now revised to 9.50%. At this point the principal outstanding was around 98.00 Lakhs.
At 9.50% per annum rate of interest, the 13th month interest on outstanding principal of 98.00 lakhs is ₹ 77,591.
The initially planned EMI is still reasonably greater than the interest servicing cost for thirteenth month.
Here, the lender Bank will ask Karan that at 9.50% on originally planned EMI of ₹ 86,782 will increase the tenure of the loan by 55 months. Alternatively, Karan will have an option to increase his monthly EMI to ₹ 92,996 to keep the tenure the same.
Let’s take one more example where the concerns of the lender will be far bigger.
Let’s say, a year back, Ranbir took a home loan of ₹ 1 Crore at 6.4% for 30 years. Monthly EMI was ₹ 62,551.
Ranbir paid the first 12 EMIs of ₹ 62,551. There was no change in rate of interest in the first 12 months.
For the sake of simplicity, let’s assume that the rate of interest, after paying the first 12 EMI’s at 6.40%, is now revised to 9.50%. At this point the principal outstanding was around 98.86 Lakhs.
At an interest rate of 9.50% per annum, the 13th month interest on 98.86 lakhs is ₹ 78,265.
What it means is that the initially planned EMI of ₹ 62,551 is not able to service the interest component calculated based on principal outstanding and interest rate.
This means that with every passing month, the principal outstanding will keep increasing and this is something the lender bank will not accept.
At this point, the lender bank will ask Ranbir to increase the EMI so that the EMI becomes reasonably greater than the interest component leaving some room for principal repayment as well.
In case Ranbir cannot afford the rise in EMI, he will only have two options –
- Figure out a way to make a part repayment to bring the principal outstanding down so that the initially planned EMI is reasonably greater than interest component;
- Sell the house and pay the entire loan.
These events are now unfolding in India. Just a few quarters ago, home loans were available at interest rates as low as 6.40%. Now the rates have been revised to around 9.5%. Home Loans are long term loans and hence banks are mostly interested only in floating rate loans.
The home loan interest rates are linked to the repo rates determined by the Reserve Bank of India. Due to various factors, the Reserve Bank of India has increased the repo rates and banks are left with no other option but to increase the rate of interest on floating rate loans.
Hence, the buyer has to understand a few things before taking a home loan –
- The interest rate cycle;
- His affordability to pay higher EMIs or make an early repayment;
- Ensuring adequate health and term insurance, and emergency funds so that the EMI repayments do not get impacted due to any emergency.
Nishant Batra CWM® is Chief Goal Planner of Holistic Prime Wealth.
Disclaimer: The views expressed in this article are of the author, not MintGenie.