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Home Loan Tenure, 15 Years or 30 Years?

Buying a home is usually one of the most important things for many of us. The process is usually long and tedious spread over anywhere between 3 to 6 months. One of the most important decisions is the financing of the purchase.

There are many factors to consider before applying for a loan. One critical factor which is always overlooked is the tenure (The duration of time in months for EMI payment) of the home loan. It is usually overlooked as the banks try and push for Home Loan with longer tenure to earn more interest for the same loan amount. Since, the EMI will be low for longer tenure, one generally tends to go with it. But is it the best option?

Well, the answer varies with one's different investment and financial goals. In the following article, we will be discussing how tenure plays a crucial role in availing the loan.

Let’s begin by taking the example of Mr. Sharat (30 years old), who works as mid-level manager for a reputed e-commerce firm in Delhi. He earns a gross salary of 30 lakhs. He lives with his family in a 1200 sq. ft. 2 BHK flat for rent in Saket, and shells out Rs 25,000 per month. The stagnant/falling property prices and attractive home loan rates have spurred a new interest in him to explore best properties in Delhi consider buying a home, which was a dream several years ago.

Sharat and his wife after thorough research, have finalized their dream home and are now evaluating financing options to be able to buy the house. He has planned to buy a property worth Rs 1 crore. But he will have to pay a down payment of 25 lac (as per RBI guidelines) out of his pocket and go for a bank loan for the remaining 75 lac. Since his monthly salary is Rs 2 lakh, he can have a maximum EMI of Rs 82,441 approved by the bank (minimum ~40% Debt/Income ratio as per RBI guidelines).

Having decided on that, Sharat is now mulling over the home loan tenure. Although, being an emotional decision, he wants to do a thorough analysis before deciding.

Sharat approaches Property experts at Commonfloor.com and shares his dilemma.

 
 

If Sharat goes for a 30 years tenure:

  • His EMI will be Rs 68,045
  • He will be eligible for tax savings on the principal and interest parts of the loan over the 30 year period. He will save 25 lakhs over 30 years given that he falls under the 30% income tax rate bracket.

If he decides to go for a 20 year tenure:

  • His EMI goes up to Rs 74,375
  • His tax savings dip to 17 lakhs over 20 years.

If he decides to go for a 15 year tenure:

  • His EMI goes up to Rs 82,441
  • His tax savings further dip to 13 lakhs over 15 years

Now, let’s understand Sharat's different goals and the best option to achieve them:

Scenario 1: If Sharat’s goal at the end of the 30 years is to have maximum net-worth, then let’s understand how all the above options stack-up.

The EMI and interest rate are important to get a maximum net-worth. For shorter tenure, Sharat will need to pay higher EMI but he can save on the loan interest to be paid. Whereas, for longer tenure Sharat will have to part-with a higher EMI amount every month.

 

Clearly, if Sharat wants to have the maximum net-worth, he should go for the highest tenure possible and have the discipline to keep investing the spare amount he would otherwise pay as EMI.

Scenario 2: Foresee more financial goals – (Bigger family, a new vehicle, children’s higher education etc.)

Sharat believes that over the next 5-10 years, he has few financial goals like having kids, education of the kids, getting a bigger car, family travel plans, and medical expenses to fulfil. If the number of dependents increase for him, it will affect his choice of going for a longer or shorter tenure. For him these might be the immediate expenses in coming years.

In this case he may choose to go with higher tenure of his home loan. This will help him lower his long term monthly outgo. The savings here and longer tax benefit can be invested in financial instruments which will help Sharat meet his financial obligations easily.

Scenario 3: Short term investing for appreciation (typically 5 year tenure)

Sharat may be looking to cash on the real estate uptrend going on few markets by investing for a short period of time and getting out as soon as he is able to make good returns. In that scenario, Sharat would want to keep his outgo to the bare minimum as he does not want to invest more than what is absolutely necessary. Also, he will try to ensure there are no prepayment charges or loan transfer liabilities which might slightly reduce his gains.

In this case, Sharat may choose to go for the longest term of home loan possible so that he can just put in minimum investment possible and use the bank leverage to gain the most.

Scenario 4: If Sharat decides to buy a house at 25 or 35 instead of 30

Although, the age of buying a property is a more detailed topic to discussion, however briefly touching upon the subject, what tenure should Sharat choose if he had an option to buy a house at 25, 30 and 35 years of age?

Given that at 25, if Sharat could afford the EMI, he should go for the shortest duration possible to pay as fast as possible. This is because, his liabilities are lesser during early years and by the age of 40 years, Sharat would have finished his payment for the house if he goes for 15 year tenure.

If Sharat decides to take the loan at 35 years of age, taking a 30 years loan will take the EMI load well into his retirement. Usually it is a good practice, to finish the liabilities before retirement. In that case, he should take the loan for slightly shorter duration of about 20 or 25 years.

Scenario 5: If Sharat is smarter financial investor i.e. he can earn higher rates of returns than a government rate of 8%. In that case which option he should go for.

Investing in Fixed Deposit, Recurrent Deposit or any other policies will give him rate of returns around 8-9%. So, Sharat having a very good financial knowledge can explore multiple options available in the market to spend his money and gain overall interest rates which may vary between 12 - 25% and more.

In this case, Sharat would like to make use of the different financial opportunities available in market and make use of them to increase his returns.

Now, to earn higher rate of returns he can go for the longest duration possible so that he can invest in the financial markets like stock options, commodity, etc. and gain more money.

Scenario 6: If Sharat foresees a turbulent employment market ahead and feels he need to account for the risk of job insecurity, then Sharat needs to review the tenure of his loan.

Future is unpredictable but it’s always good to be prepared and think of all the scenarios as taking a home loan is big decision and is for long run. Even though this factor is risky, it has to be considered. If Sharat is not sure whether his job is secure in another 10-15 years- Should he take the risk of buying a property now for shortest duration possible or delay it, till the time is right?

In this case as the market situation is not in Sharat’s favour, he can wait for 10 years to save up sufficient amount of money and then go for a shorter tenure possible to buy the home. There is also a possibility he can choose to go for the shortest tenure possible now and get his dream house before any such situation happens. This way he can free himself from one of the responsibility and need not worry in future.

Sharat needs to think through both the possible options and choose depending on his priorities, bank balance and responsibilities.

Conclusion:

Deciding on a tenure for home loan is very challenging as you have to think through all the possible options / scenarios that you might have to face while considering buying a home and applying loan for it. As we have seen in the case of Sharat that there can be many possible options to choose from and you can go for a tenure ranging from 15 to 30 years.

After going through all the possible assumptions, it is advisable to go for a longer tenure only if you can invest in a savings instrument that will generate equal returns. But, keep in mind that to invest in any financial saving instrument, you should have thorough knowledge of the market financial trends. Else, you should go for shorter tenure if you can afford larger EMIs.

Shorter tenures will help in saving more money in terms of interests paid to the bank from where you have taken the loan. If you are planning to take the latter option, you can also think of paying some of the principal amount to reduce your monthly burden in the form of EMI. The choice is yours!

Assumptions:

  • Since all the option entails 25 lakh down payment hence, have not considered the interest opportunity foregone.
  • To consider the benefits and impact of taxation on the tenure of Home loans, the model assumes the user is a first time home buyer, hence, the tax deduction assumed on Home loan Interest paid are limited to 2 lakh per annum.
  • Even though the user has sound financial knowledge about the investment options available in market, reinvestment of tax saving is not considered as it can actually complicates the case / scenarios further.
  • Fluctuations in the rate of interest for the entire period of tenure are not considered while describing all the possible scenarios as changes in the rate of interest will change the inferences every time whenever there is a change in the rate which will further confuse the audience and makes it difficult to choose an option.
  • Pre-payment scenarios cause fluctuations in the EMI to be paid for the tenure you have taken. We have not considered prepayment to avoid any confusion in the calculations of the EMI.
  • Investments are calculated at a conservative interest rate figure of 8%. The savings in this case further fluctuate if the person is willing to invest in riskier assets to get higher returns.
  • Tax savings - 30% Tax bracket for an annual income of Rs 30 lakh, Zero "Existing deduction 80C/D", Rs 1 lakh "Max Principal Tax Break", Rs 2 lakh "Max Interest Tax Break".

Read More: What does 50bps RBI rate cut mean for your Home Loan?

Fundamentals on Home Loans by Mr. Syed Haseeb – Founder, FinWizz

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