Tackling a rising home loan EMI with ease

Tackling a rising home loan EMI with ease
29 Aug, 2007, 1004 hrs IST,Vidyalaxmi, TNN

The usually smiling Ravi Raman wasn’t his usual self a few days ago. He was seen walking restlessly across his office. The IT company for which he was working informed him that his salary would be credited a little late into his account.

Mr Raman was worried since it meant his home loan cheque could probably bounce. In the past few years, the Ramans have been facing the arduous task of trying to eke out a living, thanks to rising EMIs (Equated monthly Installments).

This wasn’t the case two years ago when he took the loan. Coping with higher EMIs for many is something but a bitter truth that one has to live with. ET takes you through smart measures to befriend higher EMIs.

Managing rising EMIs

There are two ways to cope with increasing home loan EMIs. One way could be to lower your consumption needs. Then you could cough up some funds to prepay the home loan. Explains certified financial planner and wealth advisor Gaurav Mashruwala,

“You have two variants in the expenses category, mandatory and voluntary. You have to spend on food but you can cut down on eating in restaurants and entertainment. The idea is to cut down on your lifestyle. Start buying a Cambridge shirt instead of a Tommy Hilfiger. There is always scope to tone down your lifestyle and expenses to accommodate the increase in EMIs. Another way to partly prepay your loan could be to liquidate your low-yielding assets.

All you need to evaluate is how much net return does your investment fetch you. If it’s lower than the interest outgo on your home loan, it makes financial sense for you to liquidate that investment to repay a part of your housing loan.

“You can look to break your bank fixed deposits or liquidate some debt-based products. Touch your equity investments only if you are in dire need,” advises Mr Mashruwala. Typically, equity earns more than 16% annually (more than home loan rates of 12% pa) and historically, has been the best performing asset.

You need not liquidate all your investments. You can liquidate around 30-50% of your low-yielding investments, which will also take care that you have a balanced portfolio of investments. However, you have to evaluate this option very carefully. You cannot liquidate those investments which have the ability to beat inflation in the long run.

Higher EMI or tenure?

Whenever a bank/HFC hikes lending rate, you either see a rise in your EMI or an extension in the tenure. Industry experts recommend increasing the EMI than tweaking the tenure of the loan. Approximately, when a bank/HFC hikes the lending rate by 0.5%, the tenure of your loan is increased by almost 25 months. If you take a housing loan at the age of 30, you would have planned to repay by the time you complete 50 years of age. The idea would have been to spend a debt-free retired life.

Now, if you postpone the termination of loan at 52 years of age, that would impact your personal finances even more, especially if you retire, says Akhilesh Tilotia, financial advisor and director of PARK Financial Advisors. Secondly, a series of rate hikes could further postpone the closure of your home loan. So it’s better to take the EMI hit right now than postpone the impact of rate hike. The idea is you are able to realise the hike in interest rates upfront.

Even the compounding effect has huge impact on long-tenure loans. For example, if you take a Rs 30-lakh loan for a period of 15 years at 12%, then your EMI works to a tad above Rs 36,000. Essentially, you will be paying close to Rs 65 lakhs on your house, including your interest outgo. The longer you extend the tenure of the loan, this number will increase. In other words, your interest outgo is another party’s income. Why do you want to earn for a third party? Settle the loan repayment at the committed tenure.

Facts you must know

Watch your EMI

Banks say they can lend up to 48 times your monthly salary. But you should see how much can you afford by looking at the EMI as percentage of your salary. EMIs should not increase beyond 35-40% of you take home salary for a housing loan. Any other loan EMI should not go beyond 25%. Banks may recommend an EMI up to 60% of your disposable income. But you have to provide for contingencies such as a job slow down, change of job or mere liquidity needs, Mr Tilotia adds.

Don’t read too much into penalty

It’s not wise to save on the 2% prepayment penalty on your housing loan. You are actually spending 12-14% on the same loan as interest cost. Even if you take into account the tax benefit, you cannot discount the forthcoming rate hikes in the years to come. Always get out of your debt as soon as possible.

Your first house is a consumption asset

You will never sell that for money. If you look at your salary as a pie, your ideal break should be 30% EMIs, 30% to the government in terms of taxes, 20% for consumption needs and the balance 20% should be savings.