When calculating EMI, another significant factor to consider, apart from the type of interest, is the length of home loan tenure. Loan tenure means the length of time that will be taken by the borrower to repay the loan along with the interest. Generally, home loan tenure may be from 5 – 20 years with some banks allowing up to 25 years. The tenure has to be decided after considering the following factors:
The first and foremost important factor is your age at the time of taking loan also matters in deciding the loan tenure. If you are in your 20s or 30s then you may opt for a loan of 20 or 25 years. But if you are in your 50s and nearing your retirement then you cannot go for a long term home loan. It is safe and wise to pay off all your EMIs before your retirement. Extending the EMI payment beyond your retirement age is a risk and not advisable.
To illustrate with an example, suppose you are nearing 40s and you avail a home loan of Rs. 25,00,000 with the rate of interest of 12% for 20 years. Assuming interest rate either remains the same or reduces below 12%, you will pay off the loan before the retirement age of 60. However, if the interest rate goes up and you cannot afford the increase in EMI, then you will have to opt for an extension of your loan tenure. In this case, the loan tenure may go well beyond your career span and you may not be able to pay the EMI after retirement without a regular income.
Your gross monthly income (and of course expenditure too!) is the second most important criteria that determines the ability to pay EMI on your home loan. If you take a home loan for a short period then your EMI will be high; and if your home loan tenure is long then your EMI will be low. Some people, in their eagerness to get rid of the burden of loan, overconfidently choose the short term loan and take the burden of high EMI. Your EMI will be a big chunk in your monthly budget. So taking a loan with high EMI is a big risk. Moreover, if the interest rate increases then it will further raise your EMI and consequently you may land in a big financial crisis. Unexpected financial needs (such as paying medical bills for your near and dear ones OR paying high fees for your children’s education) can impact your ability to pay high EMI simultaneously and put you in the tough spot.
For example, if you take a home loan of Rs. 25, 00,000 for 20 years at the interest rate of 12% then your EMI will be Rs. 27,527. But if you take the same amount of loan for 10 years (assuming that the rate of interest is also same) then your EMI will be Rs. 35,868. So it is clear from the example that you can opt for the short term home loan only if you can afford to pay the high EMI
While calculating your EMI, you might have understood that your EMI consists of both principal loan amount as well as interest. Here you should know that the amount of interest payable on the home loan is decided by taking into consideration not only the rate of interest but also the loan tenure. If your loan tenure is long, the amount of interest payable also will be high; and as opposed to it if your loan tenure is short then the amount of interest payable also will be low. So, in short, short term loan is cheap and long term loan becomes expensive. If your aim in buying the house is to sell it for a profit, then shorter loan tenure will provide a better return on investment compared to a longer loan term.
If you consider the above example of Rs. 25,00,000 loan with the rate of interest of 12% for 10 years then the total amount payable comes to Rs. 43,04,128 of which Rs. 18,04,128 is total interest payable. i.e., 42% of the total amount payable. But if you take the same home loan for 20 years then the total amount payable will be Rs. 66,06,517 of which Rs. 41,06,517 i.e., 62% of the total amount payable.
So it is better to opt for the home loan of a long tenure but with an option to make a prepayment of the loan with fewer penalties or without any charges altogether. So that you can stay away from the risk of paying high EMI; and at the same time you will be in a position to save some money for emergencies without which you may have to live in a hand to mouth situation. Again, if you accumulate your savings over the years you can make a part prepayment of the home loan which will in turn reduces the EMI or loan tenure or you may make the whole payment and get rid of the burden of the loan altogether. If you are purchasing the home as a place to live (and not as an investment), it is better to focus on negotiating a lower prepayment penalty with the bank. This provides you an inexpensive and less risky option to reduce the loan tenure if your financial situation improves in future.