Due to lockdown imposed by the Government to curb the increase of coronavirus cases India, economic activity has come to a near standstill except for health care and essential items. This has resulted in nearly zero income for business class and job losses for salary class individuals. Moreover, income projection in near term remains gloomy. On this backdrop, Reserve Bank of India has extended optional moratorium period for loan borrowers for another three months from Jul to Oct-20. If opted, borrower can delay EMIs for three-months period but interest will continue to accrue on the outstanding loan.
As suggested by Governor, Shaktikanta Das if borrower’s income has of not been affected in recent times, he should continue to repay the loan. On other hand, if borrower’s income profile has been deteriorated then the decision of loan repayments depends upon extent of income deterioration, sufficient saving, liquidity of asset portfolio, near term expenses. Since, these factors are different for each individual, we would rather concentrate of cost of delay loan repayment.
Let’s take a case of Home loan, with residual tenure of 10 years (120 Months), loan outstanding amount INR 1 Cr and interest rate as 8%. Banks are giving multiple options to the borrowers like
|Options||EMI (₹)||Tenure||Total Amount (₹)||Extra Cost (₹)||Difference in NPV (Discount Rate 6%) (₹)|
|Normal EMI (1)||121,327.59||120.00||14,559,311.32||–|
|Additional EMI (2)||125,847.84||117.00||14,724,196.76||164,885.43||33,354.83|
|Same EMI Additional Tenure (3)||121,327.59||124.00||15,013,367.64||454,056.31||232,351.71|
|Only Interest Pay for 3 month. Additional EMI (4)||123,364.07||117.00||14,633,596.07||74,284.75||15,027.35|
* Present value is calculated as INR 100 today is not equal to INR 100, 20 years from now
Option #1: Continue with same EMIs:
The cash flow of repayments does not change, thus no extra cost to borrower.
Option #2: Stop EMIs for 3 months and Additional EMIs for residual period (117 months):
Here borrower chooses to delay EMIs by 3 months, but agree to increase the EMIs such that whole loan in repaid under scheduled time period. As shown in table above, EMI is increased by INR 4520.24 to INR 125,847.84. Borrower ended up repaying extra INR 164,885.23 for delay of just 3 months.
Option #3: Stop EMIs for 3 months and continue with same EMIs for longer period:
Here borrower chooses to delay EMIs by 3 months and keep EMI unchanged, while increasing the tenure of loan. This is most costly option. As borrower will end up repaying additional INR 454,056.31. In reality, since the borrower has not pay interest for three months, he is practically taking a new loan (equivalent to interest accrued in three months) for a period of 10 years.
Options #4: Only pay interest portion and Additional EMIs for residual period (117 months):
Here borrower choose to delay principal payment for three months but continues to pay interest portion. Moreover, borrower increases the EMIs to repay loan in scheduled period. If borrower’s profile has not been affected much, then this is preferred option.
Just to compare apples to apple, we have also calculated the present value of all these scenarios with discount rate 6%(indicative Fixed deposit rate). Clearly, additional tenure with same EMIs is mostly costly option for the borrower.
At last, borrowers are generally tempted to delay the repayment of loan and wants to hold on to cash. But the decision of delay in loan repayment, if any, should be based on near cash-flow projections. Moreover, few banks, including SBI, offers overdraft on housing loan, which gives borrower to management short term cash crunch efficiently.
Prashant Jain, FRM, is a banking professional with 6+ years of experience in currency markets. He writes about monetary and fiscal developments. He has been associated with teaching for the last 5 years. He has a keen interest in politics and cricket.