Make part-prepayments to cut home loan tenor, but don't use retirement fund

Another option is to switch to another lender who is willing to refinance at a lower rate

Interest rates on home loans linked to the repo rate have risen by 250 basis points since May 2022, putting borrowers under pressure. The number of outstanding equated monthly instalments (EMIs) has increased. In many cases, EMIs have also gone through the roof. As the accompanying table shows, a 250 basis points hike in interest rates from 7 per cent to 9.5 per cent on a Rs 50 lakh loan for a 20-year tenure can mean an increase in EMI from Rs 38,765 to Rs 46,607, a difference of Rs 7,842. The total interest burden over the loan tenor shoots up by Rs 18.8 lakh.

With another rate hike of 25 basis points expected, borrowers are worried. “Due to the steep increase in interest rates, 20-year tenors have gone up to an incredible 55 years in some cases. Since lenders don’t allow the tenor to be extended beyond the retirement age, increase in EMI is now a given,” says Adhil Shetty, chief executive officer (CEO), BankBazaar.com.

Borrowers' options

It is beneficial to opt for an increase in EMI rather than an increase in the tenor. Stressed borrowers may, however, approach their lenders. “Discuss your financial situation with the lender and make a formal request to either extend the tenor or increase the EMI. The lender will assess your situation and decide whether or not to grant your request,” says Atul Monga, CEO & co-founder, BASIC Home Loan.

If you wish to reduce the EMI or the tenor, be prepared to part-prepay the home loan. Plan your part-prepayment according to your finances. “You could voluntarily increase your EMI. Or you could make a lump-sum prepayment every year. Prepaying 5 per cent of your outstanding principal each year can bring down a 20-year loan by almost nine years. Even prepaying a single additional EMI every year can bring down your tenor by 45 months (3 years and 9 months),” says Shetty.

Heed prepayment rules

Keep in mind a few things before deciding to prepay. “Prepayment may not result in significant savings if you are approaching the end of your tenor. Moreover, if you have investment opportunities that can generate higher returns than the interest rate on your home loan, then invest your additional funds instead of prepaying,” says Raj Khosla, founder & managing director (MD) of MyMoneyMantra.com.

Avoid liquidating your emergency corpus and retirement funds to prepay. “Take into account your future financial goals, liquidity, planned expenses, and income. Draw up a plan that will not affect your savings towards other financial goals, and prepay accordingly,” says Shetty.

He says that most lenders have conditions regarding how many prepayments customers can make in a year, and the minimum amount they must prepay each time.

Should you switch?

Refinancing your loan at a lower rate by switching to another lender can also reduce your burden. A one-time fee will have to be paid. Explore this option if it results in a meaningful amount of savings. “Switch to a lender who offers flexible repayment options and is ready to waive the processing fee. After exploring loan options from different lenders, you may even be able to negotiate better terms with your current lender,” says Monga.

Do the due diligence before switching. “Compare the offers from various lenders to ensure you are receiving the best deal available. Factor in costs such as administrative fees and processing fees when considering a balance transfer and compare the total amount you will pay over the loan’s lifespan,” says Khosla.

If you are not able to adopt any of the above strategies, continue to pay your current EMIs on time. The interest-rate cycle could turn early next year. If your loan is linked to an external benchmark, you will get immediate relief. Finally, paying your EMIs on time will boost your credit score, allowing you to refinance your loan at a lower rate in the future.