Minimise the burden of moratorium
Use these few strategies to reduce the additional financial cost that has to be borne for deferring EMIS
For those who have lost their jobs or suffered a pay cut but have loans to repay, the six-month moratorium on equated monthly instalments (EMIS) allowed by the Reserve Bank of India came as a welcome relief. But the deferment carries a cost. As Rachit Chawla, chief executive officer (CEO) of Finway Capital, a nonbanking financial company, says: “Many borrowers were not even aware that there is a cost involved and that banks would charge interest on the unpaid amount. This makes EMI moratorium a costly affair and you should try to get rid of this extra burden as soon as possible.”
The impact of the moratorium can play out in two ways. The interest will be added to your outstanding loan, which will increase the EMI for the remaining months. Alternatively, the EMI could be kept unchanged, but the loan tenure could be extended ( see table).
By how much your interest cost rises depends on a few factors, the first being loan tenure. The amount of interest you pay to the bank depends on the tenor of the loan. The longer the tenor, the more interest you repay for the same loan amount and the same rate of interest.
How much additional interest you pay will also depend on where you stand in the loan tenor. Says Adhil Shetty, CEO, Bankbazaar: “Interest on a loan is front-loaded. At the start of your tenor, a bigger portion of your EMI goes towards repaying interest cost. Therefore, a person who avails of the moratorium early in the tenor of the loan will have to shoulder a larger additional loan burden.”
Let's see how this plays out in the example here (see table). Let's say a person has borrowed ~50 lakh at 8.5 per cent for 20 years, and his EMI is ~43,391. Assume you've made 12 EMI payments when the moratorium was announced. If your 5 EMIS, due in April, May, June, July, and August are deferred, then the interest amount for these five months is Rs 1,72,939. This would be added to your loan balance for the 18th month. Your best and least expensive option would be to pay the accrued interest (Rs 1,72,939 in this case) at the end of the moratorium and continue with your loan as usual.
In most cases, the auto-pay mandate for March had already got executed by the time the moratorium was announced, so the EMI deferment has occurred for a maximum of five months. The primary strategy you need to use to bounce back from this additional cost burden is to prepay. Says Siddharth Gupta, CEO, Biggpocket.com: “Prepayment can help you get rid of the extra debt that the moratorium will add.”
Cheapest option: If you have the resources, make a one-time payment in September for the interest accrued between April and August. Says M. Barve, founder, MB Wealth Financial Solution: “Not everyone can afford this. But if you have gathered this amount in those five months—it could be money lying idle in dormant bank accounts, unclaimed amounts, etc.— you should repay as that will be the least expensive option.” In the above example, assume you have made 12 EMI payments when the moratorium was announced. If your five EMIS, due from April to August are deferred, then the interest amount for these five months is ~1,72,939. This will be added to your loan balance for the 18th month. Your best and least expensive option would be to pay the accrued interest at the end of the moratorium and continue with your loan as usual.
The bounce back strategy: Taking our example, Shetty says, “If you save up for 12 months and prepay 1.2X the deferred EMIS with the 30th EMI, the extra months added to your tenure could get erased.” So, in the above example, the total of five EMI missed between 13-17 months would come up to ~43,391 (EMI) * 5 months, which is equal to ~2,16,955. And if you gather 1.2x of this amount ~2,60,346, and pay with your 30th EMI, you would be able to erase the extra tenure of 22 extra EMIS. Remember the five missed EMIS, in this case, would cause your original loan tenure of 240 months to become 267 months, adding 22 extra EMIS. As a result, your original projected interest of ~54.14 lakh will become ~63.67 lakhs, if you don't plan for a bounce-back strategy.
Those who can’t pay up the accumulated interest right after the moratorium ends should pay periodically. Says Chawla: “Those who took an EMI moratorium even when they were not in a financially desperate situation have made a big mistake. They should, over a year or so, gather as much as possible to prepay. Lending institutions won't charge you a prepayment fee.” Adds Barve: “Most borrowers have opted for an increase in the loan tenure instead of an increase in their EMI, which is understandable. But going forward every extra rupee that you have—any bonus or surplus amount, entertainment funds, etc—should go towards prepaying your loan.”
Switch to a lower-cost lender: You should also check if the interest rate that you pay to your current lender is the best you can get. If not, try to switch to a lower-cost lender. Says Gupta: “Once you have paid off the deferred EMIS, a few months after that you can switch the loan to another lender who offers a better rate. The reduced rate will lessen your burden.”