Ways to reduce your EMI

Here are a few options if high monthly outgoes are a cause for concern

Are the equated monthly instalments (EMIs) on your ongoing loans hurting your lifestyle? While many loan takers look to the RBI and banks for some relief, rate cuts — however big — do not automatically reduce your monthly EMI outgo. This is because banks keep the EMI unchanged when there is a change in the interest rate and instead modify the tenure of the loan.

For instance, whenever there is an increase in the interest rate, the tenure of the loan will automatically go up. Similarly, a fall in the interest rate will result in a reduction in the loan tenure. Banks do this to keep things simple. If you want the EMI to be adjusted with changes in interest rates, you will need to inform the bank accordingly.

Besides this, how can one reduce the monthly EMI outgo?

Refinance

Refinancing is one way to restructure your loan portfolio and reduce your monthly outgo. As the first step, make a list of all the loans you’ve taken, including the quantum, the lender, the loan type and the cost of these loans. This will help you identify high-cost loans — in terms of lenders and loan products. Once this is done, you can explore refinancing options so that you can substitute the high-cost loans with cheaper, better alternatives.

For instance, if you had taken an unsecured loan from an NBFC since you were in dire need of money and they sanctioned it in short order, you can now consider refinancing that loan with a secured loan such as home loan top-up from a public or private bank that offers you the best deal. This will help reduce not only your EMI outgo on a month-on-month basis, but also your overall interest outgo throughout the loan tenure.

Also, consider secured loan options over unsecured ones, to the extent possible. The interest differential on these loan categories can be quite significant. For instance, while the interest on a personal loan is 12-18 per cent, you may be able to currently get a home loan top-up at 9 per cent or less.

Pre-pay loan

Reducing the loan principal by pre-paying your loan is another option you can consider. This will not only help you reduce your EMI outflow but also bring down the overall interest on the loan. Whenever you get surplus cash, either by way of a gift or a bonus, you can consider repaying high-cost loans. However, there are two points that one needs to keep in mind before deciding to pre-pay loans. While it is true that a reduction in the loan obligation can give us a sense of relief and happiness, you should do it only if the cost of your loan is higher than the return on your investment. This is particularly true for aggressive investors who can generate investment returns higher than the loan cost.

For instance, if your post-tax investment return is 15 per cent and the annualised interest cost is 9 per cent, you may be better off continuing the loan and using the surplus return to meet your monthly obligations. In contrast, if you are a conservative investor earning a post-tax return of, say, 6 per cent, it is best that you use the surplus money to pay off your loan.

One other aspect to be kept in mind while evaluating pre-payment is associated costs such as pre-payment penalty, the limit on the number of pre-payments that can be made in a year and the availability of part-payment facility. This is because some banks allow only full pre-payment and discourage part-payment of loans.

Increase tenure

Finally, if none of the above-mentioned ideas suit you, you can also consider increasing the tenure of the loan. For instance, if you had opted for a two-year loan, you can consider increasing it by another year. That will leave you with additional cash on hand to take care of other family expenses. The flip side of this is that you will end up paying a higher interest overall. Given that this will increase your overall interest outgo, this can be the last resort.

The writer is an independent financial consultant

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