How to Structure a Home Loan?

The loan amount is already decided. You do not control the interest rate. The only aspects where you have discretion are:



  1. Loan Tenure
  2. Pre-EMI or Full EMI
  3. Regular home loan scheme OR Home-saver loans (such as SBI Maxgain)

#1 Choosing the Loan Tenure

We have this tendency to close the home loans as soon as possible, implying the preference for shorter tenures. 15 years instead of 20 years. If the loan tenure is shorter, your total interest cost is also lower. Note that the interest cost is lower only in absolute terms (and not in percentage terms).

However, the shorter the tenure, the higher the EMI.

  • A 50 lacs loan at 8% p.a. for 10 years has an EMI of Rs 60,664.
  • A 50 lacs loan at 8% p.a. for 15 years has an EMI of Rs 47,783.
  • A 50 lacs loan at 8% p.a. for 20 years has an EMI of Rs 41,822.

You choose the EMI based on the affordability. These EMI numbers may mean different things to different borrowers. So, no right or wrong answers here.

In my opinion, do not make it very tight. Give yourself some cushion. If you think you will have to run a very tight ship with an EMI of 60,000, go with a longer tenure and reduce the EMI. You must also factor in the possibility of a salary cut or job loss. Or even some unplanned expenses. I understand such contingencies can be addressed through a robust emergency fund. However, a buffer can reduce unnecessary mental and financial stress. And we have not even considered possibility of sharp interest rate hikes that can increase EMIs quickly. Hence, a bit of breathing space will help.

Moreover, a longer loan tenure does not necessarily mean that you must stay in the loan for the contracted maturity. You can always prepay the loan, without any penalty, whenever you want. This will reduce not only the loan tenure but also the absolute interest outgo.

#2 Pre-EMI or Full EMI

The Pre-EMI option is available only if you are buying an under-construction property.

Under Pre-EMI loans, you pay only the interest (and no principal) until you get the possession. This period of interest-only payment is usually capped, say 3 years or 5 years. So, you pay just the interest until you get possession or the completion of 3 years, whichever is earlier. Plus, you pay the interest only on the disbursed amount (and not the sanctioned amount).

These twin reliefs (interest-only EMI and only on the disbursed amount) provide you the cashflow comfort. This is especially useful if you stay on rent and must pay both house rent and loan EMI until you get possession of the new house. This post compares the Pre-EMI and full EMI loans in detail with illustrations.

Loan Amount: Rs 50 lacs. Tenure: 20 years. Interest Rate: 10% p.a.
TimelineDisbursement Tranche (Rs.)Total Disbursement Till date (Rs.)Pre-EMI (Rs.)Full EMI (Rs.)
First disbursal5 lacs5 lacs4,16748,251
6 months10 lacs15 lacs12,50048,251
12 months10 lacs25 lacs20,83348,251
18 months10 lacs35 lacs29,16748,251
24 months15 lacs50 lacs48,251 (EMI)48,251

While I speak of Pre-EMI loans, I am referring to all those loan structures where you pay a lower installment initially and a bigger EMI once the relief period ends. Step-up loans also belong here.

The problem with Pre-EMI loans is that your payments do not reduce the principal. Additionally, you are in a bigger hole if the house-construction gets stuck for any reason. The interest-only feature is only for a limited period.

In this case, the choice is quite clear. If you can afford, go with a full EMI.

#3 Regular Loan or Home Saver Loan

With a home saver loan (SBI Maxgain is a popular example), you have a twin account (let’s call it OD account). You can keep your excess cash in the OD account. To calculate interest for the month, the balance in the OD account is adjusted against the Loan amount. So, if your loan outstanding is Rs 50 lacs and you have Rs 5 lacs in the OD account, the interest will be calculated only on Rs 45 lacs.

Now, the EMI is fixed. The principal outstanding goes down as per the original amortization schedule. But the interest charged is lower.

Say, the EMI is 50,000. Principal repayment during the month is 45,000. But interest charged for the month is only say Rs 4,500 (because of OD balance). What happens to the remaining Rs 500? The interest saving of Rs 500 gets added to your OD account. Hence, the interest saved is the interest earned. And we know that home loans will have a higher rate of interest than bank FDs. Plus, this addition (of interest saved) is not even taxed since this is just your money (that did not go towards interest payment).

Over and above, you can take out the money from your OD account whenever you want. It is a good place to park your emergency funds too. Better than FD returns. Tax-free. Immense flexibility.

If the interest rates are the same, a home saver loan wins easily against regular home loan.

In some cases, the home saver loans may be available at a slightly higher rate of interest. You must see if the higher interest rate is worth the flexibility for you.

When it comes to long term commitments such as home loans, you do not have to go for the most brutally rational options. Life will spring surprises. A bit of cushion will help.



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