Understanding Home Loans: Why Shorter Tenures Save You Money

The longer the tenure of a loan, the more you end up paying in interest. This happens because interest compounds over time, increasing the total amount you owe. For example, a Rs.50 lakh loan at 9% interest for 10 years will cost you Rs.26 lakh in interest. Extend this to 15 years, and the interest jumps to Rs.41 lakh. For a 20-year loan, you’ll pay Rs.58 lakh in interest. In the first year of a 20-year loan, you might pay around Rs.5.4 lakh, but only Rs.93,000 of that will reduce the principal amount.

Experts advise keeping loan tenures short to minimize interest costs. However, shorter loans mean higher EMIs (Equated Monthly Installments), which can be challenging for young people with limited budgets. If you must opt for a longer tenure, increasing your EMI by 5% yearly can reduce a 20-year loan by nearly eight years. Increasing the EMI by 10% annually can cut the tenure to just 10 years.

Prepaying the loan can also help. If your income increases by 8-10% yearly, raising the EMI by 5% won’t significantly impact your budget. Early prepayments have the most significant effect, so start as soon as possible. Use any extra cash, like bonuses or matured investments, to prepay the loan.

For a Rs.50 lakh loan at 9% for 20 years, the EMI is Rs.44,986. It’s wise to get life insurance with a big loan to protect your dependents. Separate term insurance is better than the loan insurance offered by banks, as it remains even if you switch lenders or prepay the loan.

Most home loans have floating interest rates linked to external benchmarks like the RBI repo rate, currently at 6.5%. The reset period for these rates can vary, so choose a loan with a quicker rate adjustment.

The government offers tax benefits on home loans. Under Section 24b, you can claim up to Rs.2 lakh in interest paid as a deduction. For joint home loans, both spouses can claim up to Rs.2 lakh each, totaling Rs.4 lakh.