Successive hikes in interest rates in the last year have extended the tenure of most home loans — in fact, some borrowers now have to pay the loans till retirement. When the interest rate goes up, banks usually increase the tenure of the loan to shield borrowers from rising equated monthly instalments (EMIs). However, sometimes these extensions go on for a long period and start hurting borrowers because of high interest outflow. Taking into account the plight of the borrowers, the Reserve Bank of India (RBI) has recently come up with a set of repayment rules to empower home loan borrowers. What’s new in it and how it is going to benefit home loan borrowers? ET Wealth Online explains.
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Home loan: Hike EMIs or extend tenure — what is the usual norm?
When the interest rises, lenders usually prefer to extend a loan’s tenure instead of increasing the EMI. “Until now, tenure extension has been the default mechanism for lenders in case of a rate hike,” says Adhil Shetty, CEO of Bankbazaar.com.
Lenders often implement such decisions across the board, rather than examining each borrower’s repayment capacity separately. “This has been a usual practice so that the borrowers do not feel the pinch of a hike in EMIs immediately,” says Abhishek Kumar, a SEBI-registered investment adviser and Founder of SahajMoney.com.
Also read: Is there a charge for prepayment of home loan?
But tenure extension has its own cost as borrowers end up paying a lot of money towards interest payments. So this seemingly less-burdensome option also turns out to be a very costly one for the borrowers. “Longer tenure of loans leads to higher overall interest payments. Borrowers remain in debt for a longer duration,” says Anuj Sharma, COO of India Mortgage Guarantee Corporation (IMGC).
Borrowers who want to increase their EMIs, instead of the loan duration, have to reach out to the lender to make this happen.
New RBI mandate on home loan: What has changed?
But in a notification released on August 18,2023, the RBI asked lenders to provide borrowers the options to either increase the EMI or extend the loan tenure, or use both options together at the time of resetting interest rates on home loans. Sharma explains the RBI’s new new mandate in four points:
1) Lenders should communicate to the borrowers the possible impact of a change in benchmark rates leading to a change in EMI/tenure or both.
2) At the time of interest reset, borrowers should be given an option of switching over to a fixed rate of interest. All applicable charges for switching from floating to fixed should be disclosed in the loan sanction letter.
3) Borrowers should be given an option of extending loan tenures or enhancement in EMIs or both.
4) Lenders should ensure that the elongation of tenure should not result in negative amortisation, which means the monthly loan payments should not be insufficient to cover accruing interest rate of the loan.
This means banks may not be able to take unilateral decisions on certain aspects of a loan without taking the borrower into confidence, Shetty says.
Raj Khosla, Founder and MD of MyMoneyMantra.com, says, “The RBI has directed the banks to share an easy-to-understand loan statement that explains the total interest and principal recovered till date, annualised rate of interest for the remaining loan, the EMI amount, and number of EMIs left after every quarter.”
New RBI rule on home loans: How is it going to help you?
Now, borrowers will get a choice when the interest rate is increased. Banks will have to give borrowers an opportunity to decide whether they want to extend their loan tenure, increase the EMI or go in for a mix of both options. “However, the specifics will become clear as the banks begin to operationalise this,” says Shetty.
Let us understand with an example how this new rule is going to help a borrower.
Let us assume you started a home loan of Rs 50 lakh at 7% interest for 20 years (240 months) in 2020. Your monthly EMI was Rs 38,765 at the time of taking the loan. The overall interest will be Rs 43.04 lakh.
Let us assume the interest rate gets raised to 9.25% after three years. According to the new RBI mandate, banks will have to give you the option to either increase your EMI or tenure or use a combination of both while resetting the interest rate.
If you want to finish your 20-year loan within the remaining tenure of 17 years (considering 3 years have passed), your EMI will go up to Rs 44,978 per month. You will end up paying total interest of Rs 55.7 lakh at the end of the loan tenure.
| If EMI increases and loan tenure remains the same | ||||
| Home Loan | Rs 25 lakh | Rs 50 lakh | Rs 75 lakh | Rs 1 crore |
| EMI @ 7% for 240 months | Rs 19,382 | Rs 38,765 | Rs 58,147 | Rs 77,530 |
| Total interest payable at 7% | Rs 21.52 lakh | Rs 43.04 lakh | Rs 64.55 lakh | Rs 86.07 lakh |
| Interest paid in 36 months (Rs Lakh) | Rs 5.06 lakh | Rs 10.12 lakh | Rs 15.18 lakh | Rs 20.24 lakh |
| Loan balance after 3 years | Rs 23.08 lakh | Rs 46.16 lakh | Rs 69.25 lakh | Rs 92.33 lakh |
| EMI @ 9.25% for 17 years | Rs 22,485 | Rs 44,978 | Rs 67,466 | Rs 89,956 |
| Remaining interest payable at 9.25% | Rs 22.79 lakh | Rs 45.58 lakh | Rs 68.38 lakh | Rs 91.17 lakh |
| Total interest payable in case of EMI increase (A) | Rs 27.85 lakh | Rs 55.7 lakh | Rs 83.56 lakh | Rs 1.11 crore |
| If EMI remains same and loan tenure extends | ||||
| Home Loan | Rs 25 lakh | Rs 50 lakh | Rs 75 lakh | Rs 1 crore |
| EMI remains same throughout the tenure | Rs 19,382 | Rs 38,765 | Rs 58147 | Rs 77,530 |
| If EMI remains same, new loan tenure will be (months) | 321 | 321 | 321 | 321 |
| Revised interest payable | Rs 39.3 lakh | Rs 78.4 lakh | Rs 1.17 crore | Rs 1.56 crore |
| Total interest payable (B) | Rs 44.36 lakh | Rs 88.52 lakh | Rs 1.32 crore | Rs 1.7 crore |
| Net interest savings (B-A) | Rs 16.5 lakh | Rs 33 lakh | Rs 49.5 lakh | Rs 66 lakh |
However, if you opt to increase your loan tenure and retain your loan EMI at Rs 38,765 — the same when the loan started — the loan will continue for 321 months or 26 years and 10 months. Your overall interest payment will be Rs 88.52 lakh at the end of the loan term. You will end up paying an additional interest rate of Rs 33 lakh if you opt for a higher tenure instead of higher EMI in this case.
Raoul Kapoor, Co-CEO, Andromeda Sales and Distribution Pvt Ltd, says, “With the RBI mandate, banks are now required to provide borrowers with clear options to increase their EMI or extend the tenure of their loan, or even do both, making it more accessible for borrowers. Banks are expected to offer this flexibility regularly, providing borrowers with greater control over their loan repayments.”
Should you increase home loan EMI or extend tenure?
How should a home loan borrower decide if the best option is to increase the EMI or the loan duration, when the interest rate goes up?
Borrowers deciding to increase their EMIs should first make sure that the higher monthly payout is not punitive on their pockets and that it is well within their repaying capacities. Khosla suggests that individuals should refrain from opting for an exceptionally high increase as that will eventually exhaust cash in hand.
Extending the tenure will lower the EMI and provide the borrower with more breathing room in the monthly budget, says Kapoor. “However, this will lead to paying more interest over the loan tenure. Borrower should carefully evaluate if this is a viable option for him in the long run.”
Prepayment of loans is one of the time-tested strategies to curtail net interest outgo. “It works favourably when a lender has no-to-low prepayment charges,” says Khosla. “Try prepaying as much as you can without affecting your day-to-day expenses. Higher the prepayment, the lower the balance amount, the more moderate the interest charges and the cheaper EMIs will be.”
Borrowers should use annual bonuses or windfall gains to prepay loans as much as possible. Kumar suggests that individuals assess their financial standing in terms of funding important financial goals before going ahead with a loan prepayment. If the income increases, opt for an increase in the EMI amount as this accelerates loan repayment, add experts.
