Loan Basics. Ways to reduce your EMI outgo

Is the equated monthly instalment (EMI) on your huge loan biting into your monthly savings? Sure, repo rate cuts by the RBI so far in 2015 may have brought some cheer, but your monthly EMI would not have changed much for two reasons.

First, banks do not alter the EMIs every time there is a change in the interest rate. Instead, for convenience sake, banks only adjust the tenure of the loan. For instance, when there is a cut in interest rates, the loan tenure decreases and vice-versa.

Second, banks may not pass on the full benefit of policy rate cuts to customers. Hence, despite the reduction in rate, your monthly EMI outgo may not have changed much. In this scenario, how do you reduce your monthly EMI outgo? Read on.

First, consolidate your loan portfolio. To do this by yourself, first make a laundry list of the loans that you have taken along with the outstanding amount and interest rate/cost. Do not forget to include the outstanding amount on your credit cards too.

You need to explore the loan offers from various banks and zero in on low-cost loans. Apply for the lowest cost loan and foreclose/prepay your high-cost loan.

For instance, if you have large sums outstanding on your credit card, you can consider paying it off by taking a personal loan. This is because the interest rate on your credit card outstanding may range between 24 per cent and 36 per cent depending on the bank and card type. In contrast, you may be able to get a personal loan at a much lower cost of 13-18 per cent. This can help you save quite a bit on the interest outgo.

As the second step, try to move from unsecured to secured loans. This is because lending rates for loans that are backed by collateral are far lower than those for unsecured loans. “Switching from unsecured to secured loan can help you reduce both the interest outgo and EMI significantly,” explains Mahalingam, Managing Director, RupeeZone.

For instance, to refurbish your home, you can consider taking a top-up home loan in place of a personal loan. For instance, SBI offers home loan at an attractive 9.5 per cent annual interest, much lower than the 13-18 per cent interest charged on personal loans.

You can also consider other collateralised borrowings, such as gold loans. The interest rate on these loans may be lower than on personal loans.

Three, longer the tenure of the loan, lower the EMI. So, extending the tenure of a loan over a longer period of time can also help you reduce your EMI with immediate effect. However, reducing your EMI through this route does entail a cost.

If your loans remain outstanding for a longer period, you will eventually be paying back much more to your lender by way of interest. Therefore, extending your loan tenure has a negative impact on your long-term wealth.

This is why it is important that you go for long-term loans that can be foreclosed without having to pay a prepayment penalty. Use longer tenures to tide over any immediate financial difficulty, but try to foreclose the loan whenever you have spare cash.

Four, in case you make any windfall, don’t splurge; use it instead to prepay your high-cost loan. This will help you cut down on interest cost.

For instance, if your employer pays you a fat festival bonus, you should probably use it to pay off your credit card outstanding or your high-cost personal loan instead of going on a vacation to some exotic place.

COMMENT NOW