EMIs that stay constant or instalments that reduce over time; what should you pick?

When we think of a home loan, the immediate reaction is to estimate the equated monthly instalment (EMIs), the amount you will be repaying the bank or financial institution each month. Axis Bank Ltd has launched a new home loan variant called QuickPay Home Loan, that will not adhere to the traditional EMI concept. The bank is allowing the QuickPay customers to repay the loan in reducing instalments. This means that you do not pay a fixed monthly instalment. Instead you pay instalments that will reduce over time. However, compared to a regular EMI, the initial instalments in this loan would be significantly higher. Jagdeep Mallareddy, executive vice president and head, retail lending, Axis Bank said, “The regular home loans are structured around the EMI platform where every month there is a fixed instalment. The interest and principal component in it varies. In case of the QuickPay home loan, the principal that the customer is paying back is fixed throughout the tenure, but the instalment varies. The instalment starts with a higher instalment initially, which comes down as the loan progresses.”

EMIs that stay constant or instalments that reduce over time; what should you pick?

Let us understand what this is, how it would work and if you should consider it.

Loan repayment

In case of a regular home loan, your EMI is kept constant. For simplicity, we are assuming the interest rate to be constant throughout the tenure. The EMI comprises of interest and principal. For instance, consider ₹50 lakh home loan taken at an annual interest rate of 9% for a tenure of 20 years. In your first EMI of ₹44,986, ₹37,500 will be interest that is levied on the outstanding amount and ₹7,486 will be the principal amount that you repay. Subsequently in the next monthly instalment, the interest amount is levied on the reduced outstanding balance. The EMI however remains the same. That’s because while the interest component of the EMI reduces over time, the principal component of EMI increases over time.

The Quickpay loan works slightly differently as you don’t repay the loan in equated monthly instalments but in instalments that are fat initially and tapers off with time. This is because in this loan, the principal repayment happens at a much faster rate and consequently the interest that’s levied is also lower. So taking the same example above, in QuickPay, the first EMI will come to ₹58,333. Here, the interest is the same at ₹37,500 but the principal repayment is ₹20,833—in a regular loan the principal amount was just ₹7,486 in the first instalment.

QuickPay comes across as the cheaper alternative because here the principal component that you repay is much higher and also constant throughout the loan, thereby reducing the total outstanding every month in a higher degree compared to a regular loan as the interest outgo is much lower. In the example above, in a regular home loan, your total outgo over the years will be ₹1.08 crore, with interest component being almost ₹58 lakh. On the other hand, in the QuickPay loan, the total outgo will be ₹95.2 lakh, which would mean an interest outgo of about ₹45.2 lakh. However, there is a catch.

Higher rates

The above calculations have assumed the same rate of interest for both the regular and QuickPay loans. However, for the QuickPay loan, Axis Bank is charging a rate of interest that is 15-20 basis points higher compared to a regular home loan rate.

So if based on your credit profile you are getting a regular Axis bank home loan at 9%, you will be charged 9.15% to 9.2% for the QuickPay loan. This would take the total outgo from ₹95.2 lakh to ₹96.2 lakh, over the repayment period.

Mallareddy said that though the average repayment tenure varies based on a lot of factors, most borrowers repay their home loans in about 9-10 years on average.

For example, assuming a ₹3 lakh part payment each year from the fifth year of a regular home loan at 9% interest, the total outgo could come down to about ₹86 lakh. Similarly, assuming part payments of ₹4 lakh each year from the 5th year, the total outgo could come down to ₹83 lakh.

The QuickPay loans also allow prepayment without any charges. A person making prepayments of ₹3 lakh a year from the fifth year onwards in a Quickpay loan at 9.2% interest will bear an outgo of ₹81 lakh and ₹79 lakh if yearly prepayment of ₹4 lakh is made.

What you Should do

As the calculations show, compared to a regular home loan, the biggest challenge in the QuickPay loan would be a significantly higher monthly instalment initially. If the higher monthly instalment does not bother you, then QuickPay is a good option for you.

The QuickPay loan would save you more money in the form of interest outgo despite having a higher interest rate. A regular home loan on the other hand has the comfort of a fixed monthly instalment. In comparison, the QuickPay loan’s irregular and higher instalments initially could pose a cash flow challenge.

source: livemint


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