House EMI. Is it better to take a shorter or longer tenure?
If I take a loan for 1.000,000 and try to pay it in five years, I'll have to pay approx 20000 as EMI.
My uncle tells me to keep the tenure as 20 years (with interest rate at 10%), and my EMI will be just 7000.
He says it's an advantage because due to the rate of inflation being about 7%, the value of this 7000 will be very less in 10 or 20 years time, and will be a much better option than trying to pay it off in 5 years.
Is it really better?
[this is in India, where the house prices are rising]
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From my point , it is bad to take long tenure when you can repay higher amount every month. The reason is that the principle amount you pay every month is less in case of longer tenure. Hence you pay more to bank in longer tenure.
You take a loan amount of 20,00,000 INR for 10% interest rate per annum. Your interest amount is 19,00,000 INR for 15 year loan and 28,00,000 INR for 20 year loan . It indirectly means for availing 20 lakh loan, you're returning 40 lakh to bank in 15 year loan. Do you want to provide that amount to bank or keep it yourself for investing. If you want to keep it to yourself, keep your tenure as short as possible.
For full details , you can see my blog post on tenure.
The 5 year offer looks like a fully amortizing loan, i.e. paid off in five years. And 7.42% interest.
I'd take the shorter loan at 7.42% vs the3 10% for 20 years, but of course, it's nearly triple the payment. Can you afford this?
Interesting that the longer term rate (10%) is about 3% higher than your current inflation rate. That stands to reason, as the US rate is sub-4% with inflation in the 1% range.
As a general principle if you are able to comfortably afford Rs20 K every month, with contingency, you should go ahead. The value of Rs 7000 may be less in later years, however it does not impact anything, the other consideration you need to make is if you can afford 20 K, then paying 7 K in interest will leave you with 13 K. Are you comfortable to make an investment of 13 K in something that will return you more than 10% [the rate you are paying as interest]. If you don't believe you can get more return, then you should take the loan for shorter period.
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