Rate Cut – Should You Lower Your EMI Or Reduce The Loan Tenure?

Many lenders — State Bank of India, ICICI Bank, Axis Bank and HDFC— have slashed their home loan rates to promote affordable housing in India. This has brought down the home loan interest rates to the lowest in the last 10 years and has come out as good news for first-time homebuyers. Interest rate cut is a blessing for new homebuyers as well as the existing borrowers. However, the existing borrowers would now have to choose one of the two options — lowering equated monthly installment (EMI) or lowering the loan tenure.

When such rate reduction happens in the market, borrowers start thinking about home loan prepayment in order to make the most of it. However, a common question that strikes all such borrowers is- reducing EMI or tenure which is better.

To find out which method of home loan prepayment is better, let us first understand the impact of both the options on your finances.

1. Reducing EMI

Reducing Home Loan EMI instantly increases your monthly disposable income. For example, if you have a loan outstanding of Rs 50 lakh at an interest rate of 8.85% per annum for 20 years, a reduction of 0.50% in the interest rate of home loan will lower the EMI to Rs 42,918 from Rs 44,505. You will have Rs 1,587 more at your disposal every month. If you reduce home loan EMI, you will also save on interest as your total interest outgo for the entire tenure of loan that is 20 years will go down by Rs 3,80,983. The table given below illustrates the same-

Table1: What happens when you lower the EMI

	Old	New
EMI	Rs 44,505	Rs 42,918
Tenure	20 years	20 years
Interest rates	8.85%	8.35%
Interest savings	Rs 3,80,983

2. Shortening  the tenure

Lowering tenure of home loan means you continue to pay the same EMI and hence wrap-up your loan before time. Continuing with the above example, after the reduction of 0.50% in the interest rate, if you continue to pay the same EMI of Rs 44,505, you can close your loan in 18 years that is 2 years before its closure date. This will result in interest savings of Rs 10,01,648.

Table2: What happens when you lower the loan tenure

	Old	New
EMI	Rs 44,505	Rs 44,505
Tenure	20 years	18 years
Interest rates	8.85%	8.35%
Interest savings	Rs 10,01,648

Which one should you choose?

Essentially, both the scenarios will enable you to save money but the savings are much higher if you opt for reducing the tenure of the loan by agreeing to pay the same EMI. But if your monthly EMI amounts to 50%-60% of your take-home salary and you are struggling to pay that, in such a case you may want to opt for lower EMI to slightly lower the burden.

Understanding the EMI and tenure relationship

The tenure of the loan and EMI are inversely related. That is, the more time you take to repay your loan, lower will be the EMI and vice versa. For example, for a Rs 50 lakh home loan at an interest rate of 8.35%, for a tenure of 20 years, you will have to pay an EMI of Rs 42,917.65 while if you reduce the tenure to 15 years the EMI will shoot up to Rs 48,798.34. But the catch is, though your monthly burden will increase as you will be left with less cash in hand, your total interest outgo will go down substantially. In the above example, the total interest outgo will be Rs 37,83,701 for loan tenure of 15 years while in case of loan tenure of 20 years, the interest outgo will be Rs 53,00,236.