Impact on floating rate home loan EMI and tenure - on interest rate change
The interest rates have been very volatile in the last few years. A couple of years back, the rates were going down. And they have been moving up for some years now. What effect does a rate change have on a floating rate home loan ? Does it change the amount of the EMI? Does it alter the tenure of the repayment period? Let's find try to find answers to the above questions. With inflation rising to over 10%, the interest rates on deposits and loans have also been steadily climbing. This has meant that the interest rates for floating rate home loans have also increased significantly over the past few months. Since many of us have taken home mortgage loans with a floating rate, let's analyze how this increase effects the Equated Monthly Installment (EMI) and the repayment period / schedule.
The first step is to understand the composition of the Equated Monthly Installment (EMI) that we pay every month.
Components of Equated Monthly Installment (EMI)
Each EMI that we pay consists of two components: Interest on the outstanding amount of the loan taken, and repayment of principal. With each EMI payment, we pay back some of the loan in the form of repayment of principal. As a result, with each EMI payment, the interest component in the subsequent EMI goes down a little, and the principal repayment component increases a little. At the beginning of the repayment schedule (that is, during the initial years of the home loan repayment), the interest component is much higher than the principal repayment component in an EMI. Over years, as we repay some principal with each EMI, the interest component decreases, and the principal repayment component increases. Towards the end of the home loan repayment schedule (that is, during the last few years of the home loan repayment), the principal repayment component is far higher than the interest component in the EMI.
The following table shows the EMI (both principal and interest components) for Rs. 1, 00,000.00 home loan @ 10.50% interest for two years
| Month | Monthly Installment | Interest | Principal | Balance |
| 0 | | | | 100000 |
| 1 | 4638 | 875 | 3763 | 96237 |
| 2 | 4638 | 842 | 3796 | 92442 |
| 3 | 4638 | 809 | 3829 | 88613 |
| 4 | 4638 | 775 | 3862 | 84751 |
| 5 | 4638 | 742 | 3896 | 80855 |
| 6 | 4638 | 707 | 3930 | 76925 |
| 7 | 4638 | 673 | 3965 | 72960 |
| 8 | 4638 | 638 | 3999 | 68961 |
| 9 | 4638 | 603 | 4034 | 64927 |
| 10 | 4638 | 568 | 4069 | 60857 |
| 11 | 4638 | 533 | 4105 | 56752 |
| 12 | 4638 | 497 | 4141 | 52611 |
| 13 | 4638 | 460 | 4177 | 48434 |
| 14 | 4638 | 424 | 4214 | 44220 |
| 15 | 4638 | 387 | 4251 | 39969 |
| 16 | 4638 | 350 | 4288 | 35682 |
| 17 | 4638 | 312 | 4325 | 31356 |
| 18 | 4638 | 274 | 4363 | 26993 |
| 19 | 4638 | 236 | 4401 | 22592 |
| 20 | 4638 | 198 | 4440 | 18152 |
| 21 | 4638 | 159 | 4479 | 13673 |
| 22 | 4638 | 120 | 4518 | 9155 |
| 23 | 4638 | 80 | 4557 | 4597 |
| 24 | 4638 | 40 | 4597 | 0 |
The following table shows EMI for Rs. 25, 00,000.00 home loans for different payback periods with different rate of interest
| Calculations |
| | Interest Rate (%) |
| Years | Months | 9.50 | 10.00 | 10.50 | 11.00 | 11.50 |
| 16 | 192.00 | 25,375.00 | 26,148.00 | 26,931.00 | 27,725.00 | 28,529.00 |
| 17 | 204.00 | 24,745.00 | 25,530.00 | 26,327.00 | 27,135.00 | 27,952.00 |
| 18 | 216.00 | 24,198.00 | 24,996.00 | 25,806.00 | 26,626.00 | 27,457.00 |
| 19 | 228.00 | 23,721.00 | 24,531.00 | 25,353.00 | 26,187.00 | 27,030.00 |
| 20 | 240.00 | 23,303.00 | 24,126.00 | 24,959.00 | 25,805.00 | 26,661.00 |
| 21 | 252.00 | 22,936.00 | 23,770.00 | 24,615.00 | 25,472.00 | 26,339.00 |
| 22 | 264.00 | 22,612.00 | 23,456.00 | 24,313.00 | 25,181.00 | 26,059.00 |
| 23 | 276.00 | 22,324.00 | 23,180.00 | 24,047.00 | 24,925.00 | 25,815.00 |
| 24 | 288.00 | 22,069.00 | 22,935.00 | 23,812.00 | 24,701.00 | 25,600.00 |
| 25 | 300.00 | 21,842.00 | 22,718.00 | 23,605.00 | 24,503.00 | 25,412.00 |
Assumptions - The interest rate remains fixed during the loan tenure, Interest rate is compounded monthly, Processing & other charges which may applicable as per the rules of banks and other lending institutions are not taken into account.
The Impact of interest rate increases
Simply speaking, when interest rate increases, you need to pay a higher amount as interest for the amount that you borrow.
This means one of the two things:
· Your EMI amount increases to accommodate the increased interest payment, so that the tenure of your housing loan stays the same, or
· The EMI remains the same and the tenure of the home loan increases, so that you can pay the increased interest through more EMI payments.
EMI increases but loan tenure remains the same
This is quite sensitive – since you have to pay more interest, you pay more every month. This means that your EMI amount increases, but the overall period or duration of the loan repayment remains the same.
Let's take an example. Say you take a Rs. 10 Lakh loan for 25 years at an interest rate of 10.00% per year. Your EMI would be Rs. 9,087.00 per month.
Now, if this rate increases to 11% per annum, the EMI would be correspondingly increased to approximately Rs. 9,801 per month. (Assume that rate hike happened within three months)
Loan tenure increases but the EMI remains the same
In this case, the EMI remains the same. But since you have to pay more interest now, the number of EMIs to be paid increases. That is, the years for which you have to repay the loan increases.
Please see the following example
Mr. X started off with a loan of Rs 10 lakh with Repayment period – 15 years
Interest rate – 7.5 per cent, EMI – Rs 9,270
After 6 months…
Mr. X's outstanding capital was Rs 9,90,000
Repayment period – 15 years and 7 months
Interest rate – 8 per cent
EMI – Rs 9,270
We see that when the rate of interest jumped to 8 per cent, Mr. X's EMI did not change but the repayment period went up to 187 months, i.e., 15 years and 7 months. And this happened even after his paying off of 6 months' loan.
Does it mean, every time the rate changes, Mr. X's repayment period will increase? And how long will this go on?
To deal with this problem, different banks have adopted different conditions that usually even the borrower is not aware of. E.g., a bank might decide that for a young customer the repayment period should not be more than 25 years, while for a slightly older person it might be 20 years. As per the internal limit set by his bank, Mr. X should repay the loan by the time of his retirement, that is, at 58 years. Today, Mr. X is 37 years old which means he has an additional 21 years from now on to pay off the loan.
Let's see the latest situation
Mr. X's loan interest rate has risen to 10.5 per cent, from earlier 9.75 per cent.
His outstanding capital – Rs 9, 50,000
Considering the EMI amount remains the same, i.e., Rs 9,270, the period for loan repayments rises to 260 months, which is 21 years and 8 months.
This exceeds the permissible limit of 21 years.
What is the solution?
Mr. X's bank does not want to extend his repayment period further, so it is asking Mr. X to repay a lump sum amount on his loan in order to bring down his outstanding capital. In case Mr. X pays back Rs 25,000 then the outstanding period will drop just below the 21-year mark. But if he goes for a larger amount like Rs 50,000, it will bring down the outstanding a bit so that in case of a rate increase in the future, the figure will not require immediate action.
What should Mr. X do?
Mr. X has no choice but to make the necessary lump sum payment. This will bring down the number of outstanding EMIs, which are pushing the repayment period beyond 15 years. He can do little in case there is a one-way rise in rates but in future he can keep a track of the amount of capital and number of EMIs that he has to pay as it will tell him in advance whether he needs to make a similar payment.
Remember – Since the tenure of the home loan increases, you are repaying the loan over a longer term. Therefore, the proportion of the interest component in the EMI increases significantly in the initial years.
Which one is better – EMI increase or loan tenure increase?
Both have their advantages and disadvantages.
EMI increases but loan tenure remains the same
The biggest disadvantage is that not everyone can afford an increased EMI.
Most of us stretch ourselves when we buy a home – we try to buy the best possible home as it is a once-in-a-lifetime purchase for most of us. This means that we end up taking a loan that has an EMI that we can just about afford. Any increase in the EMI might not be sustainable by our monthly budgets. And even if you are willing to pay a higher EMI, the bank may refuse to do so in cases where the increased EMI amount becomes more than a certain percentage of your total monthly income.
But the advantage is that you have to pay for lesser number of years.
Loan Tenure increases but EMI remains the same
The disadvantage here is that you have to keep repaying the home loan for a longer period.
But the advantage is that these extra EMI payments towards the end of the loan would not pinch at all. This is a positive side-effect of inflation – it reduces the value of the Rupee each year, and by the time you reach the fag end of your repayment schedule, the EMI would form a negligible fraction of your monthly income.
Which one is better
Most banks have their own rule about choosing one of these. In that case, you would have to go by the bank's policy. But there are some banks that give the choice to the customer. In such a case, choose to keep the EMIs constant and extend the tenure. As explained earlier, although you would pay more as interest over the tenure of the loan, you would end up saving in real terms. The only problem would be for people nearing retirement – if you are nearing retirement, the bank would not allow you to increase the duration of your repayment period. For everyone else, keeping the EMIs constant and extending the tenure should be the best option.
Note: This article is for the general information of the readers. To find out the latest home loan interest rates, EMI and other terms and conditions, contact your home loan provider
Best Regards
Prakash Nair
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