Planning to take a home loan? You have shortlisted the bank with the lowest interest rate and the best feedback about the service. Well, have you given thought to the home loan tenure? Along with your loan amount and the interest rate, the home loan tenure is an important variable in determining your monthly EMI.
Shorter the tenor, higher the EMI and the loan gets repaid faster. You pay less in terms of absolute interest cost. Longer the tenor, lesser the EMI and the longer it takes to repay the loan. You pay more in terms of absolute interest cost.
Why Does This Happen?
Let’s understand this with the help of an example. Suppose you go for Rs 50 lacs loan at 10% p.a. I assume the rate of interest will be same throughout the loan tenor. EMI for 15 year loan will be Rs. 53,730 while the EMI for 30 year loan will be Rs. 43,879. Since the EMI amount is larger in the first case, principal will be repaid much faster.
In the first month, for 15 year loan, Rs. 41,667 will go towards interest payment while the remaining Rs 12,064 will go towards principal repayment.
In the first month, for 30 year loan, Rs. 41,667 will go towards interest payment while the remaining Rs 2,122 will go towards principal repayment.
| Loan Amount | 5,000,000 | |||||
| Interest Rate | 10% | |||||
| Loan Tenure: 15 years | Loan Tenure: 30 years | |||||
Year | Interest | Principal Repayment | Portion of EMI towards principal Repayment | Interest | Principal Repayment | Portion of EMI towards principal Repayment |
| 1 | 493,177 | 151,586 | 23.5% | 498,749 | 27,794 | 5.3% |
| 2 | 477,304 | 167,459 | 26.0% | 495,839 | 30,704 | 5.8% |
| 3 | 459,769 | 184,994 | 28.7% | 492,623 | 33,919 | 6.4% |
| 4 | 440,398 | 204,365 | 31.7% | 489,072 | 37,471 | 7.1% |
| 5 | 418,998 | 225,765 | 35.0% | 485,148 | 41,395 | 7.9% |
| 6 | 395,358 | 249,406 | 38.7% | 480,813 | 45,730 | 8.7% |
| 7 | 369,241 | 275,522 | 42.7% | 476,025 | 50,518 | 9.6% |
| 8 | 340,391 | 304,372 | 47.2% | 470,735 | 55,808 | 10.6% |
| 9 | 308,519 | 336,244 | 52.2% | 464,891 | 61,652 | 11.7% |
| 10 | 273,310 | 371,453 | 57.6% | 458,435 | 68,108 | 12.9% |
| 11 | 234,414 | 410,349 | 63.6% | 451,304 | 75,239 | 14.3% |
| 12 | 191,445 | 453,318 | 70.3% | 443,425 | 83,118 | 15.8% |
| 13 | 143,977 | 500,786 | 77.7% | 434,722 | 91,821 | 17.4% |
| 14 | 91,538 | 553,225 | 85.8% | 425,107 | 101,436 | 19.3% |
| 15 | 33,608 | 611,155 | 94.8% | 414,485 | 112,058 | 21.3% |
| 16 | 402,751 | 123,792 | 23.5% | |||
| 17 | 389,788 | 136,755 | 26.0% | |||
| 18 | 375,468 | 151,075 | 28.7% | |||
| 19 | 359,649 | 166,894 | 31.7% | |||
| 20 | 342,173 | 184,370 | 35.0% | |||
| 21 | 322,867 | 203,676 | 38.7% | |||
| 22 | 301,539 | 225,003 | 42.7% | |||
| 23 | 277,979 | 248,564 | 47.2% | |||
| 24 | 251,951 | 274,592 | 52.2% | |||
| 25 | 223,197 | 303,346 | 57.6% | |||
| 26 | 191,433 | 335,110 | 63.6% | |||
| 27 | 156,343 | 370,200 | 70.3% | |||
| 28 | 117,578 | 408,965 | 77.7% | |||
| 29 | 74,754 | 451,789 | 85.8% | |||
| 30 | 27,446 | 499,097 | 94.8% | |||
| Total | 4,671,446 | 5,000,000 | 10,796,288 | 5,000,000 | ||
You can see principal gets repaid much faster in the 15 year loan. Total interest paid in the 30-year loan is Rs 1.07 crores while in the case of 15-year loan, total interest paid is only Rs 46.71 lacs. Hence, you save a lot on the absolute interest cost if the loan tenor is shorter. However, do not get the impression that the 15-year loan is cheaper than 30-year loan. The interest cost is the same at 10% p.a. in both cases. Just that you are paying 10% interest for a longer duration in 30 year loan.
What Should You Do?
Many borrowers (not all) would want to repay their home loan as early as possible (especially first time buyers). However, affordability of EMI cannot be ignored. Then, there are tax benefits on home loan repayment to be looked into. Hence, on one hand is your desire to own the house completely (by repaying the loan quickly). On the other hand, you have to strike balance with an affordable EMI. In my opinion, you should not focus too much on the home loan tenure. Focus more on the other aspects. Loan tenor will automatically fall in place.
1. Affordability
You cannot borrow more than you can afford to repay. That applies to all kinds of debt and home loan is no different. Though you may want to repay your loan early, a very high EMI may lead to cash flow pressure and your investments for the other financial goals may get compromised. Fortunately, banks take care of this aspect. As I understand, banks have internal credit guidelines, where they ensure that your Fixed obligation to Income ratio (FOIR) does not exceed a certain limit, say 40% or 45%. For instance, if your monthly take home income is Rs 1 lac, then the bank will not lend to you if the EMI (for all running loans and the potential home loan) exceeds Rs 40,000 (or Rs 45,000). But the bank can only make an assessment based on documents submitted. You have much better clarity about your financial life, stability of your job and cash flows. Make a decision accordingly. If you have the financial muscle and a higher EMI does not compromise your ability to invest for your other goals, choose any tenure. It won’t really matter. In such cases, it is a matter of personal preference. Personally, in such a case, I will prefer a shorter tenure.
2. Your Loan Requirement
A longer tenor increases your loan eligibility. Sticking to the same example, the bank can only lend as much amount so that your EMI does not exceed Rs 40,000. Your loan eligibility for a 15 year loan at 10% is Rs 37.22 lacs. What if you need a loan of Rs 40 lacs? For a 30 year loan, your loan eligibility will be Rs 45.6 lacs. In such a case, you can’t go for a 15 year. You have to choose a higher tenure. Your hand is forced. There is no decision to make.
3. Your Age
You wouldn’t want a loan liability when you retire. Hence, it is advisable to choose tenure so that your loan gets over before you retire. Fortunately again, the banks will take care of this aspect too.
4. Tax Benefits
Home loan repayment comes with certain tax benefits under Section 80C and Section 24 of the Income Tax Act. Many borrowers choose to continue (or not prepay) their home loan just because of the tax benefits. I have a slightly different take on the topic. You can read my views on the hype surrounding income tax benefits on home loan. I don’t attach much weight to tax benefits. Again, it is a personal preference.
Smart Use of Annual Bonuses or Other Cash Windfalls
There is no prepayment penalty on prepayment of floating rate home loans. You can always use a portion of your annual bonuses or any other cash windfall through gifts or sale of an investment to prepay your home loan. Your home loan tenure will automatically come down.
Conclusion
There is no such thing as the ideal home loan tenure. Go with the EMI that you are comfortable with and that your finances permit. The tenure will be calculated automatically. Make sure your other goals do not suffer because of your home loan commitment. When in doubt about your repayment ability, go with a longer tenure. This will give you flexibility. You can always use your bonuses or other cash windfalls to prepay loan and bring down the loan tenor later, if you so wish.
By the way, this simple and smart advice came from a friend with little background in finance education. It reinforces my belief that personal finance is more about common sense than academic qualification.