For most of us, owning a home remains the most cherished dream. Buying a home with one’s own money is the right approach but when funds are scarce, one has to resort to getting it financed through a home loan. Most home loans require a down payment of about 20 percent of the cost of the home while the balance 80 percent gets financed.
While taking a home loan from a bank or any other lender, amongst other important things, one has to decide the tenure of the loan i.e. the repayment period.
Most lenders provide different loan tenure ranging from 5 years to as long as 20 years. Few lenders such as Punjab National Bank, Bank of Baroda and ICICI provides home loans with tenure as long as 30 years while Oriental Bank of Commerce (OBC) offer a 40-year tenure.
Let us see how it is important and what impact does it have on your loan eligibility, your EMIs and the total interest burden,
1. Loan eligibility
The quantum of loan or the home loan eligibility is primarily dependent on the income and repayment capacity of the individual. At constant rate of interest and with other factors constant, the loan eligibility increases if you choose a longer tenure. “With longer term, the EMI obligation on the borrower will be less, hence his loan eligibility will increase and he can avail a higher loan amount,” says Deo Shankar Tripathi, Managing Director & CEO.
There are several home loan calculator on the Internet that you may use especially the home loan eligibility calculator to find out your own eligibility.
Say, someone age 30 with a net take-home pay of Rs 60,000 is looking for a home loan.
At interest rate of 9 per cent, the maximum loan that the lender will offer will be around Rs 38.50 lakh at an EMI of about Rs 39,000.
Now, if the tenure is increased to 25 years, with other factors constant, the home loan eligibility increases to about Rs 46.47 lakh with no change in EMIs, nearly 20 per cent enhancement in eligibility.
2. Impact on EMI
At constant rate of interest, the home loan EMI will fall as the tenure increases.
Illustratively, here are the EMI per lakh at 9 percent interest rate.
Tenure of 15 years – EMI per lakh Rs 1014
Tenure of 20 years – EMI per lakh Rs 900
Tenure of 25 years – EMI per lakh Rs 839
Tenure of 30 years – EMI per lakh Rs 805
Tenure of 40 years – EMI per lakh Rs 771
It means, if you are taking a home loan of Rs 30 lakh for 15 years, the EMI will be Rs 30,428, while for 25 years loan, it will be Rs 25,176, almost 17 per cent lower!
With lower EMI’s, that much less is the outflow and one may consider it to mange household budget better. If the tenure is more, lower will be the outflows in terms of EMIs.
3. Total interest burden
At constant rate of interest and other factors constant, the total interest burden is more when the tenure is long. So, to keep the interest cost low, its better to choose a shorter tenure. Here’s how:
If you are taking a home loan of Rs 30 lakh for 15 years, the total interest paid at the end of the term will be Rs 24.77 lakh, while for 25 years loan, it will be Rs 45.52 lakh almost 65 per cent higher interest payout!
Lower EMI and Savings
Choosing a long term loan keeps the EMIs low compared to a medium term loan. The difference may be put to good use. “For instance, your monthly EMI for a Rs.50L loan would be Rs. 44,986 for a tenor of 20 years compared with Rs.40,231 for a tenor of 30 years. That’s a difference more than Rs.5000 a month. With lower home loan EMI, your home loan eligibility goes up, and you can opt for a larger loan amount. Moreover, if you invest that Rs.5000 in equity mutual funds, you may be able to save more than what you would have paid as interest. Even at 12% returns, you can generate a corpus of Rs.1.67Cr over a period of 30 years. So, providing your interest rate remains the same, it could mean savings,” says Adhil Shetty, CEO, Bankbazaar.com
Whom does it suit
“Salaried profiles within age group of 25-30 years and self-employed professionals and business class profiles within age group of 30-40 years are best suited for long tenure loans. This helps them to own house at a young age with additional advantage of tax exemption on permissible interest amount on housing loan and tax rebate under section 80c on permissible repayment of loan,” says Tripathi.
Choosing a longer repayment period may not apply for everyone. Lenders, typically, keep the loan maturity till the retirement age of the individual. So, while a 20 year old may get a 40-year repayment period, someone of age 35 may not be allowed by the lender to keep such a long tenure.
Sample this. In case of OBC 40-year loan, while the minimum age is 18 years, the maximum repayment age for Salaried (Non Pensionable) individuals is upto 60 years or superannuation, which is earlier. However, for salaried (with pension) & other Individuals, it is upto 75 years.
Here’s another factor to consider if one is selecting a long term loan. “The other factor is the duration itself. Your commitment would last for a very long time, probably your entire earning career and beyond, especially if you are not in a situation to prepay your loan. This means that you may be retiring with a liability. So, you would need to build a bigger retirement corpus to cover for the loan repayments,” says Shetty.
What to do
While taking a home loan, the most important thing to keep in mind, is to keep the interest burden low. And, this can be achieved by maximising the down payment and keeping the tenure short. You can also increase your home loan eligibility by adding an earning member ( say, working spouse) of your family as a co-applicant and thus avoid taking a long term loan.
However, those who are not able to arrange down payment may use of such long term loans to enhance eligibility. “Since there is no penalty on full or partial prepayment, customer always has the option to pre-pay the loan as and when one has some surplus funds,” says Tripathi.
As a thumb rule, keep the EMI within 50 percent of take-home pay and have a prepayment plan in place. Prepay as and when you have surplus funds, especially in the initial years when the interest burden is high. “Repayment of principal loan in initial 3 years is only 2.25% – 2.50% of overall loan,” informs Tripathi. After all, the early you finish the loan, you will be able to enjoy 100 percent equity in you own home.