Updated: Oct 4, 2020
Gone are the times when one used to get in to a job, work for at least 20-25 years, save money and then buy house from lifetime savings. With the opening of the Indian economy, availability of higher disposable income in the hands of consumer, growth in real estate industry and easy availability of credit options, customers have been spoilt for choice. Today, youngsters getting in to job and buying their first home within 2-3 years of completing the service has become more of a norm than exception. Availability of easy home loan facilities from banks and housing finance companies has played a vital role in bolstering this trend, coupled with the fact that tax payers running a home loan get income tax deduction to the extent of Rs 3.50 lcs per annum while filing income tax returns.
Home-loan is a long- term loan, typically ranging from min 5 years to max 30 years. While the availability of easy finance options & tax breaks undoubtedly offers a valid reason to avail the home loan, what most of the borrowers fail to notice is the total interest payment and the total cash-outflow which occurs over the loan tenor.
In this write-up we will try to understand the total cash outflow in a typical home-loan and how we can minimize by being little vigilant and pro-active.
A Home loan is usually availed by borrowers for following purposes:
1) To purchase a new house.
Completed property from builder/developing authority (Housing boards, development authority etc) or in resale market
Under-construction property in direct allotment from authority or private developer
2) Construction of house on pre-owned plot of land
3) Purchase of Plot and construction of house on the plot at a later stage
4) Renovation/Home improvement of existing house.
5) Top-up/Enhancement on existing loan
6) Take-over of the existing loan from bank or financial institution to another.
The Home loan is availed by customers for duration ranging from 5 years-30 years with age capping of 60 years for salaried customers and 65 years for businessman/self-employed customers.
While there is no doubt that availing a home loan does comes in handy to fulfill the dream and aspiration of owning a home loan, at the same time what also holds true is that the cash out flow during the entire tenor of home loan is more than double the loan amount availed.
Let’s under-stand this with an example.
· Mr. A is a salaried individual who is currently aged 30 years, purchases a house of 40 lcs from renowned developer and avails a loan of 30 lcs from a leading bank.The vital information of the transaction are as under :
Loan Amount: 30 lcs ; Loan Tenor : 30 years ; Rate of Interest :8% ; EMI per Month :Rs 22,012
Total cash outflow in 30 years: Rs 79,24,320; Interest payment in 30 years: Rs 48,14,404.
So, what we see from this example is the fact that total payment outflow> 250% of the loan amount & interest payment in itself is >160% of the initial loan amount.
So how can we reduce this cash flow and reduce the cost of loan?
Avail the loan for smaller loan duration.
Remember, high loan duration=higher interest payment & higher cash outflow
Taking from the above example, let’s see the interest payment and cash outflow for loan duration of 25 years and 20 years respectively
Loan Tenor-25 years: Total cash outflow-Rs 69,46,345; Interest payment- Rs 38,82,207
Loan Tenor-20 Years: Total cash outflow-Rs 60,22,368; Interest payment Rs 29,87,744
So, from the above example its evident just by reducing loan tenor by 5 years at the time of availing the loan approx. 10 lacs can be saved. Also, it is not be noted that the above calculation is only for loan amount of 30 lacs, as the loan amount increases so does the savings.
The option 1 of reducing the loan tenor can be exercised at the time of loan origination or availing the loan, however, there can be a scenario where due to lack of knowledge or ignorance the loan was applied for higher tenor, so what can be done in such a scenario?
No worries, all is not lost yet and certainly there is way of correcting it, let’s understand how.
Once the loan has been availed, customer has an option of approaching his bank or financial institution for reducing loan tenor and increasing the EMI. Just by increasing the EMI by 10% loan tenor can be reduced by 9 years.
In the above example if the loan has been availed for 30 years, the EMI works out to be Rs 22,012/month and a 10% increase means EMI of Rs 24612/month which means an additional payment of Rs 2600/- per month. Resultant loan tenor is 21 years which means a reduction in loan tenor by 9 years, and total payment to be done is 62 lcs against the payment of Rs 79lcs as per original tenor. This is saving of 17 lcs over the original loan tenor.
So, every year an increase in EMI by 5%-10% can help in reducing the loan tenor and resultant savings on payment to be done over entire tenor of loan.
Apart from increasing the EMI and reducing the loan tenor, there is another way of reducing the loan tenor, which is by way of making bulk payments. For salaried customers, usually bulk payments are received annually in terms of bonus/variable pay. Similarly, for business-man the payments are received in way of capital gain or outstanding payment from debtors, etc. These onetime payments can be utilized for reducing the loan obligation, as these are deducted from the loan principal outstanding and not towards the interest.
Again, going back to our example, a yearly payment of Rs 20,000/- each year can reduce the loan tenor by 6.58 years, i.e, from 30 years to 23.5 years and resultant savings of 17 lcs in total payment and 12 lcs in interest payment.
In the current scenario, most banks and financial institutions are extending loan at floating rate of interest, which means the rate of interest varies basis the change in RBI Monetary policy. The Rate of interest for a loan is usually linked to a benchmark rate of the lending bank or financial institution and basis the change in benchmark rate, effective rate of interest for a loan change. While in ideal scenario any change in rate of interest should be passed on to existing customers, in actual situation, any hike in ROI is readily passed to existing borrowers, the banks and lending institutions are usually reluctant to pass the reduction owing to the profitability compulsions. However, banks and financial institutions do offer the option to customers for switching or conversion of rate of interest as per the ongoing interest rate regime which is being offered to new customers/borrowers. What this essentially means is that existing borrowers have the option of reducing the ongoing rate of interest by pro-actively reaching out to their bank or lending institution. Banks usually charge a nominal conversion/switch fee (Rs 2500-Rs 5000) for reducing the loan tenor.
For example- In the above example a reduction of rate by 0.5% basis points from 8% to 7.5% can reduce the interest outgo by Rs 3 lacs and overall outflow by 5 lacs.
The customer gets option of either reducing the loan tenor or reducing the EMI on reduction of ROI. Therefore an aware and pro-active approach from customer can certainly help in saving money.