Suffered income loss? Opt for an interest-only home loan facility

Remember the reprieve you earn from paying full EMI comes at a price

Standard Chartered Bank has launched an interest-only home loan facility for new and existing clients, and also for those transferring their loans from other lenders.

Borrowers must understand the pros and cons of this facility before deciding to opt for it. 

How it works

The interest-only facility will be provided on the purchase of completed residential units. During a limited period at the start of the tenure, borrowers will get to pay only the interest accrued on the principal. This period can range between one and three years, after which the regular equated monthly instalment (EMI) will begin.

Lowers outgo 

Opting for this facility will reduce the borrower’s upfront cash outflow.

“Individuals will get a period during which they will be able to manage by paying a smaller amount each month,” says Adhil Shetty, chief executive officer (CEO), BankBazaar.

These loans can help in certain circumstances.

According to Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor, “The buyer may have found a house he wants to purchase, but he may have expenses right now which he won’t have in the future.”

Adds Ratan Chaudhary, head of home loans, PaisaBazaar: “This scheme can also help borrowers who expect their income to increase in the near future.”

Facility comes at a cost

The reduction in cash outgo by opting for the interest-only facility (vis-à-vis paying the full EMI) may be limited.

“During the initial period of a home loan, the EMI consists largely of interest. The principal component tends to be smaller,” says Aditya Mishra, founder and CEO, SwitchMe - a digital home loan broker.

On a Rs 50 lakh loan taken for 20 years at 7 per cent interest, the total interest a borrower pays if he avails of a three-year interest-only facility is around Rs 10,49,976. 

“This large amount does not go towards reducing the principal, which remains unchanged at the end of the interest-only period,” says Raghaw.

In this example, if a borrower had opted to pay full EMI, his principal would have come down to Rs  46,16,739 at the end of three years. When he avails of this facility, his principal remains unchanged at Rs 50 lakh.

“As a result, the total interest cost works out higher when a borrower opts for this facility,” says Mishra.

Adopt in distress  

Opting for an interest-only period, called pre-EMI, is suited to those buying an under-construction property.

“Those purchasing their first house typically have to pay rent during the construction period. Paying both rent and full EMI becomes difficult,” says Raghaw.

Paying interest-only also works in an education loan.

“It is okay to pay just the simple interest on the loan during the study period and commence the full EMI once you start working,” says Shetty.

When buying a ready-to-move-in apartment, the rationale behind paying only the interest is less strong.

“Such buyers don’t have to bear the burden of rent anymore,” says Mishra.  

Most customers buying ready-to-move-in properties should opt for a full-EMI loan. They should opt for an interest-only facility only if they have suffered a loss of income.

“Such individuals may transfer their loan to an interest-only facility and earn some reprieve. They could pay just the interest for a while and use the amount saved to pay costlier loans or those that must be repaid,” says Shetty.

Such borrowers must do due diligence. Find out from the bank the full EMI, the amount to be paid during the interest-only period, and calculate the difference. Then calculate how much you will save on interest cost by using this amount to pay off expensive loans.

“Remember that the interest rate on a personal loan is higher, but the loan amount is usually smaller. In a home loan, the loan rate is lower but the loan amount is much bigger,” says Shetty.

Chaudhary suggests switching to full EMI as soon as your cash-flow permits.