Long-Term Vs Short-Term: What’s The Ideal Tenure For Your Home Loan?

Taking a home loan is a big financial responsibility. Repaying one’s debt requires a long-term commitment and strong financial discipline. The tenure of a home loan offered by banks and non-banking financial companies (NBFCs) depends on various factors, such as whether it is a fixed-rate or floating-rate loan, the applicant's age, the type of property, and so on. Of course, the borrower can always choose a shorter term than the maximum allowed, based on their requirements and repayment capacity.

Long vs Short-Term Loan: Pros and Cons        

Short-term loans allow you to significantly reduce the interest burden. For a home loan of Rs 50 lakh taken for 20 years at a 9 per cent interest rate, you would pay around Rs 58 lakh in interest. This interest payment drops to Rs 26 lakh if you reduce the tenure to 10 years.

A short-term loan with a floating interest rate lets you benefit from lower rates by quickly completing the loan repayment before interest rates have a chance to rise again. Let’s understand this with the help of an illustration:

Suppose you have taken a home loan of Rs 50 lakh at a 9 per cent interest rate. If you repay this loan in 10 years, you need to pay a total of Rs 76 lakh. If you increase the duration to 20 years, then you have to repay Rs. 1.07 crore.

A short-term home loan is ideal when you have the financial capacity to pay large EMIs without the certainty of defaulting or having your finances stretched thin.

Most banks have waived penalties on prepayment of home loans. While a short-term loan binds you to your repayment schedule to a degree, a long-term loan allows you to make principal prepayments to close your loan ahead of schedule.

Of course, at any point, if you’re experiencing difficulties with your loan conditions, you have the option of working with your lender to reduce the EMI amount (by increasing the tenure) or increasing the EMI (thereby reducing the tenure).

A long-term home loan allows you to comfortably meet the eligibility criteria for paying an EMI based on your monthly income at the time of loan application. You may start with paying the EMI as per a long tenure, say 20 years or 30 years, but with the passage of time, your income also increases, whereas the EMI remains constant (subject to fluctuation of interest rates). Such an arrangement certainly puts you in a position to make prepayments to close your loan ahead of schedule.

Let’s understand this phenomenon with the help of an illustration:

Suppose your monthly income is Rs 120,000 and you are able to save Rs 60,000 per month after meeting all your expenses. You take a home loan of Rs 60 lakh at an interest rate of 9 per cent. If you opt for a tenure of 15 years, you have to pay Rs 60,856, which is slightly higher than what you could save every month.

But if you opt for a 20-year tenure, your EMI is around Rs 54,000, which is comfortable to manage with your income. In the future, if your income increases to Rs 1.50 lakh per month, you can prepay the loan and save your interest outgo. Therefore, a longer tenure allows you to increase the loan repayment eligibility at the time of applying for the loan.

A long-term loan with a floating interest rate is subject to rate increases, and therefore, it could cost you much more than what you had initially expected. Even a fluctuation of 0.5 per cent in the interest rate could cost you a huge amount in the long term. Also, in the long term, your financial responsibilities tend to increase, as you may have dependents such as children or aging parents.

Therefore, you need to find a way to balance your loan repayments with all your other financial responsibilities.

How To Pick Your Term

While deciding on your home loan tenure, you should focus on your income level sufficiency, prevailing and expected trends in interest rates, your age at the time of applying for the loan, prepayment charges of the lending institution, and the flexibility to increase or decrease the tenure in the future.

Banks usually allow you to take the loan until the age of your retirement. Therefore, if your current age is 40 years, then the bank will allow you to take a loan for 20 years (if the retirement age is considered to be 60 years). If your income falls short of the requisite EMI in the maximum allowed tenure, then you can opt to add a co-borrower to increase your eligibility. Banks consider the loan tenure on the basis of your repayment capacity.

Final Take

To get out of debt quickly, choose the shortest tenure. This reduces the cost of borrowing by lowering interest payments. However, it is not advisable to stretch your finances by paying a very large EMI over a short tenure, causing undue strain. You always have the option to pre-close a long-term loan or reduce your interest burden by making timely lump-sum prepayments.

Based on your loan requirements and repayment capacity, opt for the shortest route to become debt-free. This approach will optimize your interest outgo without disrupting your other financial goals.