MC Explains: Why long-term home loans are not necessarily bad

home loan

Many times, we are told to opt for short-tenure home loans. Of course, the savings on interest costs make short-term loans appear better.

For example, if you decide to repay a home loan of Rs 50 lakh at 9 percent interest rate in 15 years, you end up paying Rs 41.28 lakh as interest. But if you repay the same home loan in 25 years, you pay Rs 75.87 lakh as interest. Opting for shorter tenures does help, but long-term home loans have their distinct advantages. Here is why long-term home loans can be considered.

Cash flow

Borrowers, in a hurry to close their home loans, tend to underestimate the impact of the loan’s equated monthly instalment (EMI) on the cash flow.

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Generally, an EMI of up to 40 percent of the monthly income is considered reasonable. But sometimes borrowers opt for a higher fraction to repay faster. This is true especially in case of joint borrowers.

If a household is using a large fraction of the income to repay the home loan, there will be cash flow issues. If one of the joint borrowers loses his/her job or decides to take a sabbatical or some sudden large expenditure is incurred, the liquidity management of the house can be a tough job.

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In case of long-term home loans, the EMI is relatively less than what is payable on a short-term loan. This can offer some breathing space for the household in case there are some cash flow issues. Remember, you can prepay a 25-year home loan in 15 years, but try approaching your lender to increase your home loan tenure from 15 to 25 years, and you have to go through the scrutiny once again.

Emergency corpus

Failing to pay EMIs on time can affect your credit score. One needs to plan home loan repayment. In case of a job loss, the lending bank won’t offer any concession to the borrower on EMI payments. Hence, most personal finance experts insist on maintaining an emergency fund equal to 6-12 months of household expenses. A higher EMI on a short-term home loan calls for a higher emergency corpus, compared to a long-term home loan.

Other financial goals

Even if one manages the fine balance required for liquidity management and tide over the possibility of a financial emergency with the right size of an emergency fund, buying a house and repaying the home loan are not the only financial goals of a household.

One may have other goals, including and not limited to funding children’s education, retirement, vacations and other discretionary purchases, like a car.

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If a large chunk of income is used to repay the home loan, other financial goals may take a back seat, especially those in the short and medium term. A lower EMI amount can help you invest in equity mutual funds through systematic investment plans (SIP) and other avenues, such as recurring deposits, if you opt for a long-term home loan. Some of the non-negotiable financial goals, such as funding a child’s education, can be achieved with less stress.

Buyers beware

If you think you need some flexibility in terms of your cash flows, you can opt for a relatively long-term home loan. But ensure that you do not go overboard. Do not sign up for one that most likely go beyond your working life. So, a 30-40-year home loan can be a pain as you age.

When you opt for a long-term home loan, say, for 25 years, plan to repay it earlier. Put your savings to good use – be it an investment or for some financial goal. Do not splurge all your cash on hand. You can choose to make some part-payment each year.

Instead of tying yourself to repaying your home loan in 15 years by opting for a 15- year home loan and getting stressed over it, it is better to opt for a 25-year home loan and repay it in 15 years, with a disciplined prepayment plan, over and above the regular repayment at your discretion.

Floating-rate home loans do not charge any prepayment penalty but a debt-free state ensures peace of mind.