Make the most of moratoriums

However, if the borrower can manage his EMI from the very beginning, he should not opt for moratorium even if the offers sound tempting

RECENTLY, a major public sector bank launched a home loan scheme with a moratorium for three to five years. In it, customers have the option of paying just their interest during the moratorium, after which their EMIs are gradually stepped up in the following years. This is meant to make things a tad bit easier for customers—young professionals especially—to repay their debts. It now remains to be seen other banks start offering loans with similar features.

Moratorium on loans is not a new concept. Education loan providers have been offering this benefit to students to allow them some time to find a job in order to start repaying their debts.

The real estate sector has gone through a rough phase in the past few years. The industry awaits a revival though there have been intermittent spurts in the economy at large. Therefore a home loan with an EMI moratorium would benefit potential home buyers who have been waiting for an increase in income or a tur naround in the economy.

What is a moratorium?

A moratorium is suspension or delay of an activity. In case of bank loans, amoratorium may mean not having to pay EMIs in part or full.

In the first type, no payment is made during the moratorium. In the second, which is more common, the borrower pays only the interest during the moratorium. After the moratorium, the borrower must start repaying his loan in full, as per his agreement with the lender.

Pros and cons

Let us analyse the advantages of a moratorium, especially of the first kind where absolutely no payments are required. This is preferred by borrowers facing short-term problems in paying their EMIs but expect their financial situation to improve in the near future. For example, the borrower may have had an emergency expenditure or a loss of job, leaving him incapable of repaying his loan for a short period. A moratorium on his loan would help him immensely.

It also provides borrowers the breathing space to manage and plan their finances for the next few years during the tenure of the loan. Moreover, the interest paid during the moratorium is lower than the actual interest rate at which the loan was pro cured. The difference can be as high as 1%.

Additionally, borrowers may be eligible for higher amounts as home loan under this scheme than they would in a standard loan. It allows potential home owners to dream of a bigger home-buying budget without having to worry about the downside of paying a bigger EMI straightaway, thanks to the moratorium and the gradual stepping up of EMIs which pairs very well with a gradual increase in the home owner’s income as well.

But there are some pitfalls of the scheme as well. First, in most cases, the lending institution agrees to provide moratorium only on the principal amount. The borrower has to pay the interest right from the disbursement of the loan. At the start of your repayment tenure, the interest component of your EMI is much larger in comparison to the principal. Hence there is effectively not much to save for the borrower. For example, for a 20-year loan for R30 lakh taken at a rate of 10%, your EMI works out to be R28,951, or R202,655 annually. After one year of repayment, you would have repaid only R28,356 of your principal whereas most of 86% of your repayments— R174,299—would have contributed to interest. Hence your absolute savings in ter ms of principal repayments would be small. Additionally, the EMI amount will be higher after the moratorium period is over. This is despite low savings in the initial few years of interest payment. For example, suppose a borrower has taken Rs 25 lakh as home loan for 20 years with a moratorium period of two years. In these two years, the borrower is supposed to pay the interest only. After the moratorium, the borrower has to repay the EMI in the remaining 18 years. Naturally, the EMI will be much higher since the repayment tenure got smaller.

What borrowers should do

If you are facing a cash crunch and expect it to resolve in a few quarters or years, a home loan with a moratorium is a good option. Just like an education loan, a moratorium is required because all borrowers may not be able to repay immediately after borrowing. However, if you are purely looking at temporary savings and relief, this is not the right choice.

At the same time, if the borrower can manage EMI from the very beginning, they should not go for moratorium even if the offers sound tempting. Keeping loans unpaid for longer increases the outflow because of interest being continuously added to the principal.

Finally, if you are really keen on taking the advantage of a home loan with moratorium, take a decision based on three criteria—the moratorium period, interest rate in the moratorium period, and the EMI that you are expected to pay after the moratorium period is over.

ILLUSTRATION: SHYAM