What is the ideal Home Loan Tenure?

A friend asked, “What should be the tenure of a home loan?”

I answered, “Depends on the affordability.”

My friend replied, “Affordability is always subjective. In my opinion, go for longer tenure. This way EMI will be low. You can save more. And use the saved amount to prepay the loan. This will automatically reduce the tenure”.

It seemed counter-intuitive to me. He wanted to go longer tenure so that he could repay the loan early. To be honest, his approach didn’t appeal much to me. Well, if you are so sure that you can save more, why not start with a shorter tenure and a higher EMI in the first place. I left it at that.

However, when I reconsidered his suggestion while talking to a client, I realized he had a valid point.

Let’s first see how home loan tenure affects you as a borrower.

How long tenure affects you?

Longer the tenure, the more you pay in terms of absolute interest.

Longer tenure means lower EMI and a higher interest outgo.

For instance, EMI for Rs 50 lacs loan at 10% p.a. for a tenure of 15 years will be Rs. 53,730. EMI for a 20 year loan will be Rs 48,251.

Under the 15 year loan, total interest paid is Rs 46.71 lacs while in case of 20 year loan, total interest paid is Rs 65.8 lacs.

No surprise bank will want you to stay longer in the loan.

Do note that the cost of loan is 10% p.a. in both the cases. The difference is only in absolute interest amount.

Longer Tenure can increase our home loan eligibility

Longer tenure is not always bad.

Banks have internal policies to ensure that your loan EMIs does not exceed a certain percentage of your monthly income (say, 40-45%).

With monthly income of Rs 1 lacs and bank’s fixed obligation to income ratio of 40%, you will be considered for a maximum EMI of Rs 40,000.

At 10% p.a. and loan EMI of Rs 40,000, you will be eligible for a loan of Rs 37 lacs if you opt for loan tenure of 15 years. For a loan tenure of 25 years, your loan eligibility goes up to Rs. 44 lacs.

Hence, increase in loan tenure is a way to increase your loan liability.

Hence, many a times, when you are looking for a higher loan amount, your hand may be forced. You may have to go for a longer duration.

There is a drawback too with longer tenure. When the interest rates goes up, banks typically increase the loan tenure and keep the EMI same. However, if your loan tenure is already stretched and the bank cannot increase the tenure further, the bank will have to increase the EMI. This can be a problem if you cash flows are stretched.

What should be the ideal home loan tenure?

In my opinion, you should not focus too much on home loan tenure. Focus on the following aspects.  Tenure will automatically fall in place.

1. Consider affordability of EMI

If the EMI for shorter loan tenure is not affordable, then shorter tenure is simply not an option.

Go for the tenure that makes the EMI affordable.

In fact, banks give good weight to this aspect. A bank may not be comfortable offering a loan with EMI greater than 40-45% of monthly income (Fixed obligations to income ratio). By the way, the bank will consider your other running loans too.

In my opinion, your loan EMIs should not exceed 40-45% (will vary from case to case) of the take home pay. If it does, your ability to invest for other financial goals is likely to get severely compromised.

If affordability is not a problem and higher EMI does not affect your ability to invest for other goals, then it is your choice.

Personally, I would go for a shorter tenure.

2. Use annual bonuses or any windfall to prepay loan

If you plan to prepay your loan (much before original tenure), use annual bonuses or gifts or any matured investment to prepay the loan.

3. Your age is important

You wouldn’t want to have a loan outstanding when you retire. Hence, if you are 40, don’t go for tenure greater than 20 years (assuming you retire at 60). Banks will take care of this aspect.

4. Tax Benefits

Personally, I wouldn’t give too much weight to this aspect. In my post on hype surrounding tax benefits for home loans, I have discussed this aspect in detail in the aforementioned post.

About the ideal tenure, there is no right or wrong answer.  Choose an EMI you are comfortable with. Make sure that your other goals do not get compromised because of home loan commitment.

In my opinion, when in doubt about repayment ability, go for a longer tenure. Even if you have started with longer tenure, you can use salary hikes and any cash windfalls to prepay your home loan and reduce loan tenure.  So, my friend actually made a lot of sense.

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Deepesh Raghaw

Deepesh is a SEBI Registered Investment Adviser and an alumnus of IIM Lucknow. Deepesh provides customized Financial Planning and Investment solutions to his clients. Deepesh is passionate about personal finance and contributes regularly to leading Business Newspapers. Deepesh appears regularly on personal finance shows on Business Television.

8 Responses to What is the ideal Home Loan Tenure?

  1. ABC says:

    I think you mean “tenure”, not tenor. Please correct.

  2. Hemant says:

    Sir I agree that for longer tenure EMI will be less and interest outgo will be more. However if we save the difference in the EMI and invest it in the instruments like SIP and RD, then value of the the investment will be same as that of the difference in interest outgo.

    • Deepesh Raghaw says:

      Hi Hemant,
      Yes, that is an approach. Equity funds can generate better returns (than the cost of your loan) over the long term. That is no guarantee though.
      Btw, returns from a RD will be much lower than cost of your loan. Better to pay higher EMI than investing in a RD.
      But yes, I do not contest your idea.

  3. Hemant says:

    Sir, let me explain with some numbers.

    Lets take example of home loan of amount 50 lakh and tenure 10 years and 20 years. I will consider interest rate of 9%.

    For 10 years
    EMI = 63,338
    Total Interest Payable = 26,00,546

    For 20 years
    EMI = 44,986
    Total Interest Payable = 57,96,711

    Difference In EMI = 18,352
    Difference In Interest Payable = 31,96,165

    Lets say that I make RD 18,000 of the saved EMI for 10 years.
    ED Amount = 18000
    Interest Rate = 6%
    Maturity Amount = 29,60,120

    If you see here that with higher tenure, I am paying only 2,36,045 more. Considering that it lowers my financial burden, I will opt for higher tenure.
    I also hope to gain from the tax saving on the paid interest.

    So for me, higher tenure is the better option.

    Requesting your comments.

    • Deepesh Raghaw says:

      Hi Hemant,
      Personal Finance is personal. What may be a good decision for you may not be as good for me.
      I have already mentioned that decision about tenor is subjective.
      You must note the pre-tax cost of loan is same in both cases i.e. 10% p.a.
      What I didn’t agree with you was only about the choice of investment product.

      It is very unlikely that RD will be better post-tax returns that the post-tax cost of the loan.
      Do note RD interest is taxable too.

      In a way, you will have approximately 30 lacs at the end of 10 years by investing the surplus (I assume there is no tax on RD).
      With that, you will have to pay 45K emi for the remaining 10 years. IRR is well in excess of 13% p.a. Hence, low return RD is not a good choice. An equity angle makes better sense.

  4. Hemant says:

    Yes, RD is not a right choice because of the taxable interest. I just used it to demonstrate my point that even if with low rate of interest of 6.5% can save you more. MF sip is definitely way to go. However not everyone likes to take risk.

    You mentioned about 45k EMI for remaining 10 years. So your point is person will be paying total 54L for remaining 10 years. But the point you are missing here is that you still have 30L in your pocket which are invested for remaining 10 years.

    If you consider 6% CAGR (Compounded Annual Growth Rate) on your invested 30L for the remaining 10 years then you will end up having 54L as well. If you take 8% CAGR then the amount is 64L. That means you achieve more if you don’t pay your home loan and stay invested as long as CAGR on your investment is more than 6%.

    If you don’t want to be invested for the remaining 10 years period then thats fine as well. At the end of first 10 years, your balance amount will be approximately 33L. You can pay-off the balance amount using your 30L that you have saved.

    My point is very simple. Home loan is the most affordable loan and don’t pay it off if ROI is less than 10%. Take advantage of tax benefit on interest and principle. You should pay-off your home loan as early as possible when the interest rate is high i.e. more than 10%.

    This is math and I hope this makes clear. I will appreciate if you have another angle to look at it.

    • Deepesh Raghaw says:

      Dear Hemant,
      My limited argument all along has been that you should not invest in a product which provides lower post tax returns than post-tax cost of loan. And it was quite likely the case with RDs. RDs will most likely provide lower return. Other options mentioned by you such equity investment may provide better returns. Hence, it may be a good choice assuming you are investing for the long term.
      If the post-tax return is lower than the cost of loan, no proper mathematical analysis will support a longer tenure.
      I have maintained in my post too that longer tenure gives you better flexibility.

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