Saturday, September 24, 2011

Increase in EMI or increase in tenure or part prepayment

With day by day increasing interest rates in India and in some other countries as well, many home loan borrowers are wondering which is the best option for them?
1. Increase in EMI
2. Increase in tenure
3. Part-prepayment to keep the same EMI and tenure.

Let's take an example. The borrower has a home loan of 30 lakhs (30,00,000) for a duration of 20 years. Let's say the rate of interest was 9% and so the EMI was 27,000.

Scneario: Rate of interest increases from 9% to 10%

Option 1: Increase the EMI to 28,980 and keep the same tenure of 20 months
Option 2: Increase the tenure to 26 years, 2 months and keep the same EMI
Option 3: Make a part-prepayment of 2,05,000 and keep the same EMI of 27,000 & the same tenure of 20 years.

Which one is better? Let's look at all the 3 options. Let's look at what would be the total outgo in complete repayment of the loan in all the 3 cases.

Before interest rate increase (rate at 9%): Principal = 30,00,000. Interest = 34,75,000. Total outgo = 64,75,000.
Option 1 (Increase EMI): Principal = 30,00,000. Interest = 39,33,000. Total outgo = 69,33,000.
Option 2 (Increase tenure): Principal = 30,00,000. Interest = 54,67,000. Total outgo = 84,67,000.
Option 3 (Part prepayment): Principal = 30,00,000 (including part prepayment). Interest = 36,76,000. Total outgo = 66,76,000.

As you may notice, the principal amount one repays remains the same, as that is the loan one has taken. The difference is in the interest.....and what a difference!! Another thing to notice is that the total outgo in all the three options is higher than the current situation - this is obviously because the rate has increased from 9% to 10%. So the borrower is worse off than before. But by how much is the question? How much worse off the borrower gets depends on what option the borrower chooses. Let's see.

As is obvious, the best option is to go for partial prepayment to keep the EMI and tenure the same, but again it requires a lumpsum payment which may not be possible due to financial constraints.

The next best option is to pay higher EMI, again subject to whether one is able to afford the increase in EMI.

The last and the worst option for the borrower is increase in the tenure of the loan. No wonder, banks increase the tenure of the loan by default unless you specifically ask them to increase the EMI or opt for part prepayment. The banks will opt for increase in EMI or part-prepayment only if the tenure is getting too long and is not allowed by their policy. The bank's choice is in the bank's best interest and not yours.

So, visit the bank. And ask them for other options. Ask what would be the increased EMI if you want to keep the same tenure? Or how much prepayment you can make to keep the same EMI and same tenure. Even if the bank charges a 2% penalty on partial prepayment, it may be worth it. Give it a thought!! Visit the bank and get to know your options!!

Note: The calculations are rounded off and may be off by a bit (a couple of thousands). But they are accurate enough to make the right point! :-)


  1. Among Option 1 and 3, which one will be better, if there is no change in interest rate?

    1. Will depend on the specific situation. In general - if prepayment is possible, that will save interest cost. So option 3 will be better. But also depends on what else can you do with that money if not prepaying.

  2. Is it better to increase EMI or save the increased amount over the old EMI & do prepayment at end of every quarter? e.g should I increase EMI from 17000 to 25000 OR save 8000 (25000-17000) every month & do a prepayment of 24000 at the end of every three months ?