Facing a cash crunch? Take the moratorium, but increase EMIs later

Vipul Patel

These are tough times for individuals and businesses, given the cash crunch they face due to the nationwide lockdown declared by the government to contain the Corona Virus Disease (COVID-19). The Reserve Bank of India’s (RBI’s) move to allow a moratorium on three EMIs relating to home, vehicle, education, consumer durable loans as well as to credit card customers, will offer them a lot of relief. However, since it is a deferment and not a waiver, the interest payable over the total tenure will go up if you opt for it. It’s optional and the consumer has to make the choice of opting for or out of it.

Here are scenarios to know how you can offset the rise in interest by increasing your EMI later.

Scenario 1: Moratorium not availed

To understand the impact of higher interest payment after the moratorium, let’s first understand how your repayment schedule and EMIs will look like (assuming your home loan is linked to the repo rate) if you do not opt for a moratorium. Here, considering the 0.75 per cent point repo rate reduction announced by the RBI on March 27, the home Loan consumer who had borrowed in October 2019 at a rate of, say, 8 per cent will now pay only 7.25 per cent. This reduction, in effect, will lead to a reduced loan repayment period of 250 months. A clear saving of Rs 15.39 lakh on interest outgo, assuming the EMI – of Rs 34,732 - is maintained (see table).

On the other hand, if you choose to reduce your EMI instead of shortening the tenure, your new EMI will be Rs 32,553. In this case, your net saving will be Rs 6.42 lakh. Either way, the consumer has a distinct advantage, though it is better to maintain the current EMI for more savings.

Given the huge savings that are possible due to RBI’s rate cut, it is recommended that the moratorium should not be availed if you have enough cashflows and don’t foresee a short-term crunch.

Scenario II: Moratorium availed

Let’s understand the construct of the moratorium offered. It allows customers to postpone three EMIs. The Interest payable during the three-month moratorium will be accumulated and added to the outstanding loan amount. This will result in increase in loan tenure and therefore, increase in overall interest to be paid over the tenure. So, your loan tenure will get extended by up to 264 months, as against 250 months if the EMI moratorium was not availed. Therefore, the moratorium will result in you paying 14 EMIs more.

So, if you have chosen the moratorium because you are facing a temporary financial distress, but don’t want to pay higher interest over the loan tenure, what should you do? There’s a solution. If you want to nullify the impact of the three-EMI moratorium – assuming things go back to normal and cashflows return – increasing the EMI by Rs 1,335 per month from the 25^th month will yield the desired results.

The tabulation hereunder clearly outlines the impact of the three-EMI Moratorium. On availing the scheme, by default, the loan tenure will be impacted and consequently the overall interest on the loan – unless you choose to opt for EMI Revision or any other options in consultation with your bankers.

What happens if your loan is linked to the MCLR?

Home loans, like floating rate retail loans, taken between April 1, 2016 and October 1, 2019 are linked to MCLR. It is highly recommended to write to your bank and move from marginal cost of funds-based lending rate (MCLR) to repo-linked lending rate-based loans. RLLR-based pricing is more transparent and will help realise the impact of policy rates from the immediately following month.

The MCLR for home loans is pegged at an annual reset by most banks, leading to a kind of fixed rate for a year and this is not in the interest of the consumer in a reducing rate scenario.

Most MCLR-based home loans are currently running at a rate of over 8.50 per cent. Assuming the loan was availed in January 2019 and the MCLR Rate was reset by 0.25 per cent in January 2020, the overall interest on your loan would be Rs 59.43 lakh.

Further, assuming that you do not avail the moratorium scheme, the overall interest payable would stand at Rs 50.54 lakh, assuming further MCLR reduction of 0.50 per cent. Instead, should you choose the three-EMI Moratorium, other things remaining the same as explained above, the overall interest payable will be 55.27 lakh.  That is, you will be paying 16 EMIs more.

If you want to negate the impact of higher interest payable due to the moratorium, you can, after things go back to normal, increase the EMI. In the calculations, we have assumed that if the EMI is increased by Rs 1,360 per month from the 25^th month, it will yield the desired results. That is, your interest outgo will be the same as it was before opting for the moratorium.

To sum up, the three-EMI moratorium will definitely give the consumers a breather in managing their cash flows and is a “Positive Move,” creating financial convenience. So, should you have a cash flow crunch and have difficulty in managing the EMI, do write to your banker/lending institution and seek the moratorium. It will cost you extra interest, but that can be set off in the long run. If you have a surplus or enough cashflows, it is advisable not to avail the moratorium. It will not only give you substantial financial benefits, but will also help banks and financial institutions in assisting the really needy during this crisis.