Home loan borrowers: Pay higher EMI every month or extend your loan tenure? How to choose after a rate hike

A rise in home loan interest rates presents borrowers with a choice that can affect their finances for years. They can increase their equated monthly instalment (EMI) to repay the loan faster, or extend the repayment tenure to keep monthly outgo under control. While the second option offers immediate relief, it can increase the total interest paid over the life of the loan.

The right decision depends on a borrower’s income stability, existing financial commitments, savings and the number of years remaining on the loan, said Mehernosh Tata, managing director and chief executive officer of Godrej Housing Finance.

“Those with stable income and sufficient room in their monthly budget may consider increasing the EMI to limit the additional interest cost. Others may prefer extending the tenure to keep their monthly outgo manageable, while recognising that this will increase the overall cost of the loan,” Tata said.

How a 25-basis-point rate hike affects your home loan

Consider a borrower with a ₹50 lakh home loan and a 20-year repayment tenure. If the interest rate rises from 8.5% to 8.75%, the monthly EMI would increase from ₹43,391 to ₹44,186, an additional ₹795 a month, according to calculations provided by Tata.

The increase in the interest rate would also raise the total interest payable over the loan tenure from approximately ₹54.14 lakh to ₹56.05 lakh, assuming the revised EMI is paid over the original 20-year period.

Borrowers should assess this additional cost alongside their monthly cash flows before deciding how to respond to a rate reset. Those who can comfortably accommodate the higher EMI may be able to limit the additional interest burden by retaining the original tenure.

However, borrowers already managing substantial expenses, other loan repayments or irregular incomes may find it difficult to absorb a higher EMI. Extending the tenure can help them manage their monthly budget, although the loan will remain outstanding for longer.

Higher EMI versus longer tenure: What costs less?

Increasing the EMI while retaining the original tenure helps repay the outstanding principal faster. Since home loan interest is calculated on the outstanding principal, reducing it more quickly helps contain the overall interest cost.

Extending the tenure, on the other hand, spreads repayment over a longer period. This reduces the immediate pressure on the borrower’s monthly budget but means interest continues to accrue for additional months.

For the ₹50 lakh loan in the example, Tata said that keeping the EMI unchanged and extending the tenure by 12-13 months could take the total amount repayable to ₹59.41 lakh.

The figures are illustrative and actual outcomes will depend on the outstanding principal, remaining tenure, prevailing interest rate and repayment terms. Borrowers should ask their lender for a revised repayment schedule showing the EMI, remaining tenure and total interest payable under both options before making a decision.

The difference between the two choices can be particularly significant when the outstanding principal is high or the loan is still in its early years. At that stage, a larger share of each repayment generally goes towards interest, making the pace of principal repayment an important consideration.

What options do borrowers have after a rate reset?

Borrowers do not necessarily have to accept a higher EMI or a longer tenure without assessing alternatives.

The Reserve Bank of India (RBI), under its August 2023 framework for floating-rate loans repaid through equated instalments, requires regulated lenders to communicate changes in EMI or tenure and provide borrowers with options to manage the impact of rising rates. These include increasing the EMI, extending the tenure or combining the two. Borrowers can also make partial or full prepayments, while switching to a fixed interest rate is subject to the lender’s applicable policy and terms.

A partial prepayment can help reduce the outstanding principal, potentially lowering the interest burden. However, borrowers should avoid using up their emergency savings merely to reduce their home loan liability. Maintaining adequate liquidity for essential expenses and unexpected financial needs remains important.

Switching to a fixed-rate loan may offer greater certainty over future repayments, but borrowers should compare the revised interest rate, conversion charges and applicable conditions before opting for it.

The precise options and costs depend on the loan agreement and the lender’s terms. Borrowers should seek a written explanation of the available choices and their long-term financial implications before accepting a revised repayment schedule.

Ultimately, the decision should balance affordability today against the total cost of borrowing. A higher EMI may suit borrowers with stable incomes and sufficient monthly surplus, while extending the tenure may be more practical for those who need to preserve cash flow. The key is to compare the full repayment cost rather than focus only on the immediate change in EMI.