Dear Sir,

Read your excellent article. I have very recently opted for EMI increase, but keeping tenure constant at 20 years. My arguments are as follows:

a) I am 38 years old. Pyschologically, I would like to have paid FULLY for my home before retirement at 58 or 60.

b) Today I have the capaity to pay a few thousand more in EMI - given an uncertain economicenvironment, I may or may not be able to do so in my 50's.

c) By keeping tenure fixed, when the Interest rate is high, I pay a higher EMI ( and therefore a higher amount of the Principle too). But when Interest rates fall, my EMI falls too ( so I pay a smaller amount of Principal - and therefore enjoy the benefit of the lower rate of interest). Secondly, as my EMI falls in a low interest period, I have more cash in hand for any alternate, better yielding investments.

Keeoing these possible High and Low interest situations in hand, ihave taken my decision.

Please comment if this was sensible.

I agree with you - age plays a very important role in this decision. You would definitely not want the EMIs to continue till the time of your retirement.

And in any case, our decisions would depend on our personal situations.

Having said that, here are a few points to consider:

1. Interest rates go through a cycle. We saw the rates dropping to around 7% (for home loans) around 2004-05, and then, they have been rising.

But just like the very low rates, even the high rates would not be permanent.

Thus, when the rates would go down in the future, the tenure would reduce again.

2. If you can afford extra payment, a better idea would be to prepay some of your home loan. (Most banks offer free part-prepayment of housing loan)

This entire amount would go towards repayment of the principal. Therefore, you would be paying interest on a lower outstanding amount.

Also, this would mean that the tenure of the loan would reduce.

3. When the EMI increases due to rise in interest rates, most of the increased payment goes towards payment of the increased interest. (Not surprising, coz the increase in EMI is due to increase in interest rate!)

Let me use the same example that I used in the article.

For a Rs. 20 Lakh home loan for 20 years at 10.5%, the EMI is Rs. 19,968. For the first EMI, the interest is Rs. 17,500 and the principal is Rs. 2,468.

If the interest rate increases to 11%, the EMI would be Rs. 20,644 for a Rs. 20 Lakh home loan for 20 years. For the first EMI, the interest is Rs. 18,333 and the principal is Rs. 2,310.

Thus, the interest component increases by Rs. 833, and - hold your breath - the principal component decreases by Rs. 158!

(To find the exact changes to your EMI, please download this free "Home Loan Amortization / Repayment Schedule")

Of course, even when you opt for increasing the tenure, the interest component of the EMI increases (as you would now repay the loan over a longer duration).

But this example is just to remove the misconception that you pay a higher principal when EMI increases.

Thank you - your comments are indeed eye opening.

A query on your point (1) : Why should Tenure reduce, if the interest falls in future ( as I have opted that EMI gets adjusted, but the Tenure remains constant) . Similarly, if I prepay apart of the loan, keeping Tenure constant, won't the EMI come down? Why would the Tenure get affected, under the options that I have exercised?

Hi Shraman,

Sorry for the confusion - I was still arguing for increase in tenure!

In your case:

1. If interest rate falls, your EMI would fall.

2. If you prepay, your EMI would go down.

hope that clarifies!

Hello - My bank increased the ROI, and sent a letter asking for higher EMI from 4months later. In these 4 months, the interest component is higher than the EMI amount - thus, my outstanding principal goes on increasing.

Is this a fair practice?

Hi,

I think there is some misunderstanding.

During the initial years of a home loan, the interest component is greater than the principal component. Over time, interest component keeps decreasing, and ultimately becomes less than the principal component.

So, it is very natural that the interest component is higher than the principal component.

But this doesn't mean that there is no principal repayment and that the outstanding principal is inc reasing - it just means that the outstanding principal is reducing at a slower pace!

After the rate hike, the share of the interest component in the EMI would increase even more - this is to accommodate the higher interest rate.

Thanks for the reply, but you misunderstood my question.

I perfectly understand the dynamics of interest and principal component in the EMI. Let me rephrase my question:

Recently, my bank sent me a letter informing abt increase in rate of interest wef Aug 1, 2008, and asked me to deposit the enhanced EMI chq from Jan 2009.

The trouble is: after the increase, the interest part is greater than the EMI, so the outstanding principal goes on climbing for the 4 months (spet to dec).

I believe they should have asked for enhanced EMI cheques from Aug itself.

Thought?

Hi Ambarish,

Ok, now I understand your question :-)

Usually, banks either increase the tenure or the EMI amount - increasing EMI with a lag is a bit strange.

And you are right - there is no fun in paying just the interest, and increasing the outstanding principal! This doesn't sound very fair on you.

You can probably talk to the bank, and tell them that you are willing to pay the increased EMI immediately. I don't see a reason why the bank would disagree.

One more thing: Most banks ask for EMI cheques in advance. Have you given such cheques till Dec 2008? That might be one reason why the bank is asking for higher EMI only from Jan 2009.

Hi raagvamd ,

Thnaks for the nice posts and advice.

I have taken homeloan 2 months back and have been paying the EMI.Now if the interest rate is reduced by say 1% by the bank today then when i will be getting the EMI on the reduced rate . Does it depend on the bank or I need to talk to them ?

thnks,

Prasanta

Dear Prasanta,

Thanks for the good words...

When banks announce a cut in loan rates, they also declare an effective date for it. So, your EMI will reduce depending on that.

The bank would intimate you about it, but there is no harm in proactively approaching the bank.

By the way, please check if the rates have been reduced for existing home loan customers - many times, banks reduce rates only for new customers.

Thanks Raagvamd for the input.I will check with the bank and hope it's for existing customers as well.

thnks,

Prasanta

I have taken home (floating) loan almost a year back.

Mostly banks reduce interest rates for new customers (when overall indications from repo /reverse repo rate and othr RBI indicator point to reduced intereset rates)

Q: is when does really the EMI go down for existing customers?

Thanks

--Abhay Werty--

Hi Abhay,

This is an interesting question, with no concrete answer.

The floating rate that a bank charges its existing customers depends on the Prime Lending Rate (PLR) of the bank.

This PLR should ideally fluctuate in line with the changes in interest rates (repo / reverse repo etc as you pointed out), but there is no defined rule linking the banks PLR to the market rates (like MIBOR).

Therefore, it primarily depends on the bank when to lower this rate, and thus, to lower the floating rate of the home loans. And the EMI actually goes down only when the bank lowers this rate.

Note: instead of lowering the PLR, many banks issue new loans at a discount to the PLR, say PLR - 1%. In such cases, existing customers keep paying the higher rate, and new customers enjoy the benefit of a lower rate!