An interest rate hike hurts all borrowers. For the same service (loan), you must pay more every month. Or pay the same amount but for a longer period. Neither is a desirable outcome for a borrower. And yes, the rate hikes hurt the borrower running a tight budget a bit more. In such cases, the ability to handle an increase in EMIs is rather low. In this post, let’s explore a different tangent and look at the impact of rate hikes on borrowers for different home loan tenures.
Your home loan is like a floating rate bond for the bank. Yes, the bank is the investor here. And the present value of all your EMIs discounted at the prevailing loan interest rate shall amount to the current loan outstanding. When the loan interest rate goes up, the present value of your EMI payments comes down. But the bank won’t collect anything less. Thus, to make up for the increase in discount rate, you have 2 options:
- Pay the same EMI for a greater number of years (EMI unchanged but increase in loan tenure) OR
- Pay a higher EMI for the same number of years (Loan Tenure unchanged but a higher EMI)
However, is the increase in EMI or the increase in loan tenure same for all the home loan tenures?
Loans with Longer Tenures Are Affected More
| Amount | 5,000,000 | 5,000,000 | 5,000,000 | 5,000,000 | ||||
| Interest rate | 7.50% | 8.50% | 7.50% | 8.50% | 7.50% | 8.50% | 7.50% | 8.50% |
| Loan Tenure (Months) | 240 | 240 | 180 | 180 | 120 | 120 | 90 | 90 |
| EMI | 40,280 | 43,391 | 46,351 | 49,237 | 59,351 | 61,993 | 72,807 | 75,323 |
| Revised Tenure (if EMI unchanged) | 300 | 205 | 129 | 94 | ||||
| Increase in EMI (Tenure unchanged) | 3,112 | 2,886 | 2,642 | 2,516 | ||||
| % Increase in EMI (Tenure unchanged) | 7.72% | 6.23% | 4.45% | 3.46% | ||||
| Increase in Tenure (EMI Unchanged) | 59.53 | 24.63 | 8.66 | 4.41 | ||||
| % Increase in Tenure (EMI Unchanged) | 24.8% | 13.7% | 7.2% | 4.9% | ||||
As you can see, the higher the loan tenure, the greater is your sensitivity to interest rate movements. In case of interest rate hikes, the borrowers with longer loan tenures suffer more. In percentage terms, the EMI hikes are higher or tenure extensions are longer.
The results are not surprising. As a borrower, you pay a higher interest rate on your loan when the rates go up. Clearly, if the tenure is longer, you must pay a higher interest rate for a longer period. And thus, you expect the impact to be higher.
What Do You Do to Reduce the Impact?
We have seen, the longer the loan tenure, greater is your sensitivity to rate hikes. Hence, if you are much worried about the impact of interest rate hikes on your loan EMI, you must reduce the loan tenure aggressively. And how do you reduce home loan tenure? By part prepaying the loan on a regular basis. There is no other way.
Well, there is another reason why your loan tenure can go down. An interest rate cut. But you don’t control it. That’s just luck. You already know that. Don’t you?
The mathematics behind reducing balance loans is so simple that the source of all favorable things is either loan prepayment or an interest rate cut.
Long Tenure Is Not Always Bad
A long tenure is not necessarily a bad thing. In fact, it gives you more flexibility. And the EMI is also lower.
Earlier in this post, we considered a scenario where the interest rate increased. And the borrowers with the longer tenure witnessed greater pain. Now, let’s see the impact if the interest rates were to go down.
| Amount | 5,000,000 | 5,000,000 | 5,000,000 | 5,000,000 | ||||
| Interest rate | 8.50% | 7.50% | 8.50% | 7.50% | 8.50% | 7.50% | 8.50% | 7.50% |
| Loan Tenure (Months) | 240 | 240 | 180 | 180 | 120 | 120 | 90 | 90 |
| EMI | 43,391 | 40,280 | 49,237 | 46,351 | 61,993 | 59,351 | 75,323 | 72,807 |
| Revised Tenure (if EMI unchanged) | 204 | 162 | 113 | 86 | ||||
| Decrease in EMI (Tenure unchanged) | 3,112 | 2,886 | 2,642 | 2,516 | ||||
| % Decrease in EMI (Tenure unchanged) | 7.17% | 5.86% | 4.26% | 3.34% | ||||
| Decrease in Tenure (EMI Unchanged) | 35.58 | 18.38 | 7.43 | 3.98 | ||||
| % Decrease in Tenure (EMI Unchanged) | 14.8% | 10.2% | 6.2% | 4.4% | ||||
As you can see, the outcomes have just reversed. The borrowers with the long tenures benefit the most in the event of a rate cut.