Home loan borrowers have been badly hit, as a result. The impact is in the form of longer tenures and higher EMIs (equated monthly instalments).

Consider a borrower with Rs30 lakh outstanding on his home loan and a remaining tenure of 20 years @ 9.50%. If the borrower wants to keep his EMI constant, a 0.25 percentage point rate hike (i.e., to 9.75%) can increase his tenure by over a year. If the rate goes up to 11%, the tenure will increase by as much as 17 years. Over the period, if the rate goes up by more than 2 percentage points, it would lead to negative amortisation, a situation where the EMI is not able to cover even the interest component. The borrower has no option but to increase his home loan EMI. If the borrower plans to increase his EMI and keep the tenure constant, a 0.25% increase in the interest rate will lead to a 2 percentage point increase in EMI. If the interest rates go up to 11.5%, the EMI can increase by as much as 14%. The solution: take steps to manage the loan.

A bit of number crunching shows that, increasing your EMI is far more beneficial if your tenure is longer than 10 years. In the above-mentioned case, a Rs2,000 increase in EMI can save you approximately Rs18 lakh. The impact of a hike in interest rate reduces with the remaining tenure. Therefore, the best way to reduce the burden of an interest rate hike is to reduce your tenure. The way to do it is to make partial prepayment or to increase your EMI.

How effective are these methods? Taking the example cited, say after three years, the balance principal remains around Rs28 lakh, and the rate increases to 11%, the borrower would have to pay for another 24 years approximately. If the borrower makes a part prepayment of 10% of the outstanding, he would be able to reduce his tenure by around seven and a half years and save around Rs22 lakh. If he increases his EMI by 10%, the tenure would come down by around seven years and he would save around Rs17.5 lakh. The more he pays initially, the more he will save. click to calculate your home loan emi calculator

And this can be done systematically every year. “The sad part is that people only take action when it is a bit too late,” says Renu Sud Karnad, managing director, HDFC Ltd. For example, imagine a Rs10-lakh loan is taken for 20 years @ 11.25% and the outstanding term now is 19 years. If the borrower increases his EMIs every year by 7%, he would repay the loan in 11 years, assuming the interest rate is same throughout the repayment term. In the same case, if the customer makes a part prepayment of Rs50,000 each year, he would repay the loan in 11 years approximately instead of 19 years, assuming the interest rate is same throughout the repayment term. He could also opt for both methods but a part prepayment would be more effective as it directly reduces the principal, unlike the EMI which consists of the interest component as well. But it all depends on the individual’s financial situation.