If you have taken a home loan to buy the house of your dreams, then the home loan EMI is the biggest expense you will have each month. Home loan EMI comprises of 30-40 percent of an individual’s take home salary. This is a big chunk of your income and it doesn’t leave you with enough funds to invest in your financial goals. To avoid paying a higher EMI, people take loans for a longer tenure and that makes the EMIs affordable. But what one doesn’t realise is that by extending the tenure you are also paying more interest. you can use loan repayment calculator to make your calculations easy.
When you invest for a longer term, the compounding is in your favour. When you are borrowing for a long term, the compounding works against you. If you have taken a loan for Rs.50 lakhs at 10% interest per annum, and if you choose 10 years for repayment, the EMI will be Rs.66,075 and the total interest paid will be Rs.29,29,044 and the total interest as the percentage of the principal will be 59%. If you choose 15 years for repayment, the EMI will be Rs.53,730 and the total interest paid will be Rs.46,71,446 and the total interest as the percentage of the principal will be 93%. If you choose 20 years for repayment, the EMI will be Rs.48,251 and the total interest paid will be Rs.65,80,260 and the total interest as the percentage of the principal will be 132%. If you choose 25 years for repayment, the EMI will be Rs.45,435 and the total interest paid will be Rs.86,90,511 and the total interest as the percentage of the principal will be 173%. As the loan tenure increases, you pay more towards the interest cost. You pay more towards the interest component because most of the EMI in the initial years goes towards paying the interest and very little principal amount is repaid.
If the loan tenure is smaller, you will repay the principal amount much sooner. If you have borrowed Rs.50 lakhs at 10% interest, with a loan tenure of 25 years, only Rs.2.9 lakh is paid towards the principal loan amount for the initial 5 years. If you take the loan for 10 years, then you will repay Rs.18.9 lakhs of the principal amount in the initial 5 years.
Having established that opting for a smaller repayment tenure is ideal, you must also take into consideration that the EMI is affordable. If not then you will be in a huge debt before you know it.
How can you reduce the interest burden?
If you have already taken a home loan, then you can consider the following two ways to decrease the interest burden:
- Decrease the interest rate. When you lower the interest rate, the interest pay-out is also lowered. This can be done by refinancing the loan at a lower interest rate.
- Repay the principal amount as fast as you can. The faster you repay, there is less principal amount on which you have to pay interest on. Pay more than the EMI whenever you can. The extra amount that you repay will go towards servicing the principal amount of the loan and this will reduce the interest burden.
If you have taken Rs.50 lakh loan at 10% interest for 25 years, then the monthly EMI accounts to Rs.45,435. The total interest will cost you Rs.85.3 lakhs for 25 years. You can consider from the following to reduce the total interest cost:
- Pay one extra EMI in a year:
You can prepay 1 month EMI for a year. You can pay that from your annual bonus or from your savings. By doing this your interest cost will go down to Rs.62.3 lakhs and the loan will be repaid in 19 years and 1 month.
- Increase EMI by 5% each year:
The increase can be lined with the increase in your salary. If your salary increase by 5% every year, increase the EMI repayment accordingly. The loan will be repaid in 12 years and 11 months and the total interest will cost you Rs.44.99 lakhs.
- You can pay one extra EMI in a year and also increase the EMI by 5% every year:
By doing so you will have repaid the loan in 11 years and 8 months and the interest payment will cost you Rs.39.4 lakhs.
- Refinance the loan at a lower interest rate:
The rate cuts are most often not passed on to the existing borrowers. If you are aware of the rate cut, then look out for banks offering you lower interest rate and refinance the loan. If the interest reduced to 9%, the EMI on Rs.50 lakh for 25 years reduces to Rs.41.959. The total interest payment is lowered by Rs.10.42 lakhs. Refinancing a loan means you will have to consider the switching fee, processing fee and legal fees being charged. Once you have refinanced, you can consider the above options to further reduce the loan interest repayment burden.
Every time you take a loan, make sure the EMI is affordable. Before you decide to prepay the loan, also check if it is beneficial for you. You also get tax benefits for repaying the principal loan amount each year. If the interest rate is fixed, then you may have to pay a prepayment penalty, but the interest savings will come down.
