Should you Reduce your EMI when the Interest Rate Lowers - Home Loan Blog - Tata Capital

Why Reducing Your EMI after RBI and Bank Rate Cuts can be a Bad Idea?

Mar 08, 2017

If given a chance, will you prefer paying a higher EMI or a lower one? If you are like most people, you will choose a lower EMI. After all, who wants to have an additional burden if paying higher EMIs for loans that run for several years. Isn't it?

But this might not be a good choice. Let's try to understand why.

When interest rates fall, lenders can given borrowers a choice between reducing EMI (and keeping the tenure same) or reducing the tenure (and keeping the EMI same).

Now if you do the calculations, you will realize that as the home loan tenure increases, more money has to be paid towards interest cost. On the other hand, when the loan tenor is smaller, a higher part of the EMI is used for paying back the principal every month. And since the interest is calculated on the outstanding principal amount, faster principal repayment leads to lower absolute interest payout.

Here is a simple expel to help you understand this:

Suppose you have taken a 20-year loan of Rs 50 lac at a rate of 11%. You would be paying an EMI of around Rs 51,609 for this loan. Now suppose banks reduce the interest to 10.75%.

If you decide to reduce your EMI (and keep the tenure same), your new and reduced EMI will be Rs 50,671, less by Rs 938.

But suppose you listen to your investment advisor and increase your EMI by few hundreds to Rs 52,429. Do you know what impact this will have?

It will lower the tenor to 18 years. Apart from that, you also save Rs 8.58 lac as interest cost during the full tenure of the loan.

This is the reason why it is advised to not reduce your EMIs after rate cuts. You not only reduce the loan tenure but also the interest costs.