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Making the most of your loan tenure

Regular part prepayment helps reducing the EMI burden and lowers the tenure

Close on the heels of RBI slashing its SLR rate by 100 basis points to 23 per cent,the State Bank of India has announced a cut in the home loan and car loan interest rates with effect from August 7,2012. Home loan interest has been cut to 10.25 per cent from the existing 10.50 per cent for loan amounts below Rs 30 lakh,whereas the loan amount between Rs 30 lakh to Rs 75 lakh will now attract interest at the rate of 10.40 per cent.

The maximum cut of 85 basis points has been announced on the loan amount above Rs 75 lakhs. The banking sector is expected to follow the trend with increased liquidity in the days to come. The base rate is standing unchanged at 10 per cent at the moment,so existing bank borrowers would not get the benefit of any rate reduction.

On the other hand the loan repayment can be up to a maximum of 30 years or until the borrower reaches the age of 70,whichever happens earlier. Also,other aspects to note include a loan conversion option for existing borrowers with the base rate being retained at 10 per cent. A processing fee for procuring loans apart from which there will also be property verification fee,stamp duty charges that will be applicable for the loan applicants also need to be accounted for in the total cost equation.

Other banks are expected to follow suit with the festive season just around the corner. As always several aspects need to be considered before opting for a loan in the current situation. In this article we will explore the relationship between EMI and loan tenure.

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When you start out to repay your home loan generally,the repayment schedule is worked out in a manner that allows not more than about 40-50 per cent of your monthly gross income to be repaid as EMI.

If you invest too much into it,there might not be adequate funds to manage a huge list of other expenses that will tend to accumulate with time. For example,you need to make allowances for future expenses like education of children,emergency funds for a job loss or the loss of one income in a situation where two people have taken a joint loan.

In such a situation especially in the current context where inflation is eating into everyday expenses a loan repayment with a maximum tenure can ease the monthly burden and help you manage the loan with ease. You can enjoy this benefit in the short term but always set a long term goal to try and close your loan before the maximum tenure ends.

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Also,in another scenario,there might be spikes in interest rates. Usually banks will increase the loan tenure in order not to put the loan taker in a tight spot by increasing his EMI. To help save on the total interest outgo on your loan,if you have adequate funds in hand you could prepay at intervals,allowing scope for closing your loan early. When you make a part-payment,the amount will be deducted directly from your principal,which means you will pay up your loan faster than the term it requires. Remember the longer the tenure the more the interest you will be shelling out. Try to prepay during the first half of your loan tenure as your interest part of the EMI is the highest during the initial stages and becomes smaller towards the latter part of the tenure. (See illustration)

Hence,regular prepayment,whenever you are allowed to start prepaying can help you save significantly on the money you shell out in the long term for your home loan. You can use online calculators available to calculate the amount of interest you will actually shell out with an increase in tenure and lower EMI.

— The author is head,Content & Research,BankBazaar.com

First published on: 18-08-2012 at 03:12:06 am
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