Should You Choose a Lower EMI or Shorter Loan Tenure?

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Equated Monthly Instalment (EMI) has two main parts: the principal amount and the interest charged on the loan.

Here is how EMI and loan tenure work together:

• If your loan tenure is long, you can pay a small EMI each month. 
   
• You pay a small EMI but a longer tenure keeps your EMI for more years so at last your interest becomes more.
   

• If you are choosing a Long-term loan, your loan's larger part goes towards interest instead of reducing the principal amount.

   

• A loan with a lower EMI can have a much higher total repayment cost when you compare it with the same loan taken for a shorter period.

   

When Should You Choose a Lower EMI (Longer Tenure)?

If you are someone with responsibility and want money for other expenses and spend a little money on EMI, you can go for a longer tenure. 

Here are the main situations where choosing a lower EMI makes sense:

• Tight Monthly Budget: When your monthly income leaves only a small amount after you pay your regular household expenses.
   
• Better FOIR Management: When you need to keep your Fixed Obligation to Income Ratio (FOIR) within the lender's acceptable limit for loan approval.
   
• High Career Growth Potential: When you are at the beginning of your career and expect your salary to increase in the coming years, allowing you to make prepayments later.
   
• Prioritising Higher-Return Investments: When you think you can earn better post-tax returns by investing your extra money in options such as equity mutual funds instead of using all the money to repay your loan. However, investments also carry risks.
   

• Building Emergency Funds: When you need extra money to build and maintain an emergency fund instead of paying a very high EMI every month.

   

When Should You Choose a Shorter Loan Tenure (Higher EMI)?

If you have stable and enough income which is sufficient for expenses and can spend a high amount on EMI then you should definitely choose a shorter loan tenure. This way your loan repayment will end soon. 

Here are the key situations where a shorter tenure can be useful:

• Stable and High Disposable Income: When you have enough money left after paying your regular expenses and maintaining your emergency savings.
   
• Substantial Interest Savings: When you want to reduce the total amount of interest you pay to the lender.
   
• Approaching Retirement: When you want to finish your major loans before your regular working income stops.
   
• Psychological Relief: When becoming debt-free faster gives you peace of mind and allows you to use your future income for other financial goals.
   
• High-Interest Loans: When you have a high-interest loan, such as a personal loan or other unsecured credit, where a longer tenure can increase your total interest cost.
   

Lower EMI vs. Shorter Loan Tenure

Before choosing tenure for EMI payment you should always compare both of these types. It helps you to understand the pros and cons of each tenure. 

If you have stable and enough income go for short tenure and if you have many financial responsibilities and want to spend only a small amount of income on EMI then go for longer tenure. 

Illustrative Example: 

Suppose you take a 50 Lakh Home Loan at 8.50% Interest. Now you don't know which type of loan you should choose. Here is the difference. 

Choosing a 30-year tenure reduces your monthly EMI by Rs. 10,791, but it increases your total interest payment by almost Rs. 50 Lakh.

Conclusion 

After getting a loan, you are liable to repay the debt on EMI basis. It is up to you to choose the EMI type. You can choose it depending on the time period. If you have many financial responsibilities and leave only a small amount of money for other expenses, you can choose a longer tenure for loan repayment. And if you have no such responsibilities and have enough money to pay EMI, you should definitely choose a shorter tenure. 

If you choose a longer tenure you pay less money monthly but have to pay more interest at the end of repayment. While, if you choose a shorter tenure, you have to pay a large amount of money monthly but your loan repayment will end soon. Before choosing any option you should consider your monthly income and expenses. This approach can help you keep your monthly EMI manageable while reducing your loan period and interest cost over time.

FAQs

What is the main benefit of choosing a shorter loan tenure? 

The main benefit of choosing a shorter EMI is that you save a large amount of money on total interest. Apart from this you end the repayment very soon. But before choosing this option you should consider things like monthly income and financial liabilities.

Does a lower EMI mean I pay less money overall? 

No, it doesn't work like this. If you choose a longer EMI, you need to pay less monthly as EMI but have to pay for a longer time. You have to pay more interest on the remaining balance every month. 

Can I change my loan tenure after loan disbursement? 

Some banks allow borrowers to change their loan tenure or increase their EMI during the repayment period. This depends on the lender's terms and approval.

How does loan tenure affect my FOIR? 

A longer tenure usually gives you a lower EMI. This can reduce your monthly fixed obligations and may help lower your FOIR when you apply for a loan.

Is there a prepayment penalty on floating-rate home loans? 

There is no prepayment penalty on floating-rate home loans. You can make partial prepayments or close the entire loan early without paying any extra amount.

What is the 50/30/20 budgeting rule for EMIs? 

The 50/30/20 rule is a general budgeting method that divides income into needs, wants, and savings. It is not an RBI rule for setting your EMI. You should choose an EMI based on your income, expenses, existing loans, and savings.

What happens if I make one extra EMI payment every year on a long-tenure loan? 

An extra payment can reduce your outstanding principal. This can help you reduce the loan tenure and total interest, depending on the lender's terms.

Is it better to invest surplus money or prepay a home loan? 

It depends on your financial situation. If your investment earns better post-tax returns than your loan's interest cost, investing may be an option. However, investments carry risk. Prepaying the loan gives you a more certain saving on future interest.

Which option is recommended for personal loans longer tenure or shorter tenure? 

Personal loans usually have higher interest rates than many secured loans. If you can comfortably pay a higher EMI, choosing a shorter tenure can help you reduce the total interest cost.

Can I step up my EMI every year as my salary grows? 

Yes, some lenders offer Step-Up repayment options. You can also ask your lender if you can increase your EMI every year as your income increases.