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Home loan: Choose the best term

A home loan, usually being of a large amount than other retail loans, is structured as a long-term loan. While other retail loans are typically of a maximum tenure of 5-7 years, housing loan tenures range from five to 20 years.

Most borrowers tend to borrow for the maximum term they are eligible for, since EMI payments are lower for longer –term loans. For example, for a Rs 10 lakhs housing loan at an interest rate of 8%, the EMIs for 5,10,15 & 20 year tenures will be Rs. 20,277, Rs. 12,133, Rs. 9,557 and Rs. 8,365 respectively. Thus, the EMI for a 20-year loan is significantly smaller than that of a 5-year loan.

However, the total amount that you will pay over the term of the loan will be Rs. 12.17 lakhs for a five-year loan, Rs 17.20 lakhs for a 15-year loan and Rs 20.08 lakhs for a 20-year loan. Thus, for a 5-year loan you would pay a total interest of Rs 2.17 lakhs, Rs. 4.56 lakhs for a 15-years loan and 20-years loan, the interest payout would total up to a staggering Rs. 10.08 lakhs- on a principal of just Rs 10 lakhs.

It is obvious therefore; that the longer the term of the loan, the higher will be the interest you pay to your financier, even though the EMIs may be more manageable. It is imperative therefore, to always consider whether you need to go in for a long-term loan or if a shorter-term loan would be suitable.

The longer the term of the loan, the higher is the maximum loan amount you can avail for a given income. For instance, for an 8% loan, for a gross monthly income of Rs 50,000 you can avail of a maximum loan of Rs. 9.87 lakhs for a 5-year tenure, but for a 20-year tenure you can avail up to Rs 23.89 lakhs. Thus, if you need a higher loan, you can consider going in for a longer term.

Financiers usually take care to ensure that your debt servicing is comfortable and lend a maximum amount such that the EMI dose not exceed 40% of your gross monthly decided what EMI he would be comfortable servicing. In the above example, you may require only Rs 9.87 lakhs. However, for a 5-year tenure you’re EMI for Rs. 9.87 lakhs would be Rs20,000. If you feel that your monthly expenses including tax, salary deductions etc exceed Rs 30,000 you may wish to reduce your EMI. By going in for a longer term, you can reduce your EMI. By going in for a longer term, you can reduce your EMI while keeping the loan amount constant. For instance, for a 20-year loan of Rs. 9.87 lakhs at 8%, your EMI would work out to just Rs 8,262 leaving you with a surplus of over Rs 41,00 after deduction of EMI from GMI.

Thus, there are some circumstances in which it may be preferable to choose a longer term. However, if you are comfortable servicing the relatively higher EMI, you should opt for a shorter-term loan, since your total interest payout would be lower.

Choose your loan tenure; therefore, based on both your desired loan amount as well as the EMI you are comfortable servicing. Do not however, underestimate your financial responsibilities, or overestimate the maximum EMI you can repay. Consider the maximum EMI you would be comfortable servicing currently and in future. If you expect your financial responsibilities to increase, you may want to factor in a buffer, and take a longer term, so that your repayments remain comfortable.

Once the loan is disbursed, you should try to make prepayments as frequently as possible so as to reduce the principal and therefore the intrest burden, which is higher for longer-term loans. For example, if you take a Rs 10 lakh, 20-year loan at 8% interest rate, and prepay Rs 1 lakh every year, keeping your EMI constant, you will be able to repay your loan in seven years, resulting in a total saving of almost Rs 7 lakhs. The more you prepay initially, the more you save.

Over a long term, there are likely to be many changes in interest rates and product offerings. Therefore, it is essential to keep an eye on market developments and where beneficial , switch to a more suitable product, either with your current financier or with a new one.

Thus, by managing your housing loan actively over its term, you can mitigate the drawbacks of a long-term loan to some extent.

 


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