What your loan really costs

The number nobody shows you

Walk into a bank about a ₹25,00,000 home loan and you will be told the EMI. At 8.75 percent over 20 years, ₹22,093 a month. It sounds manageable, which is exactly why it is the number offered.

Here is the figure that rarely comes up unprompted. Over 240 months you will pay ₹53,02,264. The interest alone is ₹28,02,264, which is more than the house cost. You are buying the property once and paying for it slightly more than twice.

This is not a scandal. It is what borrowing money for twenty years costs, and often it is a perfectly sound decision. But it should be a decision made with the total in view, not just the instalment.

The tenure trap

This is the mechanism that costs Indian borrowers the most money, and it works by looking like a favour.

You say the EMI is a little high. The response is to extend the tenure. The instalment drops, everyone is relieved, and the paperwork proceeds. Here is what actually happened, on the same ₹25,00,000 at 8.75 percent.

Tenure	EMI	Total interest	Total paid
10 years	₹31,332	₹12,59,803	₹37,59,803
15 years	₹24,986	₹19,97,519	₹44,97,519
20 years	₹22,093	₹28,02,264	₹53,02,264
25 years	₹20,554	₹36,66,077	₹61,66,077
30 years	₹19,668	₹45,80,304	₹70,80,304

Read the first and third columns together. Moving from 20 years to 30 saves you ₹2,425 a month and costs you ₹17,78,040 in extra interest. That is the trade. Two and a half thousand rupees a month against nearly eighteen lakh.

Going the other way is just as striking. Moving from 20 years to 15 costs you ₹2,893 a month more and saves ₹8,04,745. If you can absorb the higher instalment, that is one of the better returns available to you anywhere.

Why the effect is so large

Because interest accrues on the outstanding balance for as long as the balance exists. A longer tenure means the debt shrinks more slowly, so there is more of it, for longer, generating interest. The extra years are the most expensive ones, since they are pure interest on a balance that took two decades to get small.

What the headline rate hides

The advertised rate is not the cost of the loan. Add these.

• Processing fee. Commonly 0.25 to 1 percent of the loan, sometimes with a cap. On ₹25,00,000 that is ₹6,250 to ₹25,000, paid upfront.
• Legal and technical valuation. A few thousand rupees for the bank to check the property and its title.
• Documentation and administrative charges. Small individually, and there are several.
• Insurance. Often presented as a requirement and frequently not one. A single premium policy bundled into the loan can add a substantial sum, and because it is added to the principal you pay interest on it for the full term.
• Stamp duty on the loan agreement, which varies by state.

Together this commonly reaches one to two percent of the loan. The right question to ask, in writing, is: what is the total amount payable including every charge? A lender offering 8.6 percent with a one percent fee can easily cost more than one offering 8.75 percent with no fee, and comparing rates alone will never show it.

On the insurance specifically

Term cover for the loan amount is often a sensible thing to have, particularly if your family would struggle with the EMI without you. But you do not have to buy it from the lender, and a separately purchased term policy is frequently considerably cheaper than the single premium product offered at the loan desk. Ask whether it is mandatory. Usually it is not, whatever the tone of the conversation suggests.

The floating rate mechanism

Most home loans here float against an external benchmark. When it rises, the bank can raise your EMI or extend your tenure. Most extend the tenure, because it generates no complaints.

The cost is invisible and real. A one percentage point rise absorbed by tenure extension on a 20 year loan can add several years to the term. Your EMI never moved, so nothing felt like it happened, and you will be paying for considerably longer.

After any rate change, ask for the revised amortisation schedule and check the new end date. If you can afford a higher instalment, ask them to raise the EMI and keep the tenure.

A sensible way to decide

1. Work out the shortest tenure you can genuinely service. Not the shortest you can imagine servicing in a good month. If one missed EMI would create a crisis, it is too short.
2. Get the total amount payable in writing, including all fees, from every lender you are considering. Compare those totals, not the rates.
3. Stress test it. Run the EMI calculator at two percentage points above the offered rate. If that instalment would break you, borrow less.
4. Plan to prepay early. A prepayment in year two removes nearly seven times the interest that the same amount removes in year fifteen. Direct bonuses and windfalls at the loan while they still do the most work.
5. Clear small loans first. A ₹15,000 car loan EMI reduces your home loan eligibility by around ₹17,00,000. Clearing it before you apply does more for you than negotiating ten basis points.

When a long tenure is the right answer

To be fair to the other side of this. If a longer tenure is what makes the loan affordable at all, and the alternative is not buying, then the extra interest may be a price worth paying. If your income is likely to rise substantially, taking a longer tenure now with the intention of prepaying aggressively later is a defensible plan, provided you actually do it.

What is not defensible is drifting into a 30 year tenure because the EMI looked comfortable and nobody mentioned the other column. Choose it, with the total in front of you.

Common questions

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Written by Khanjan Kavani, who builds software in Surat and writes these to answer the questions clients keep asking. Found a mistake? Tell me at hello@khanjankavani.com and I will correct the article itself.

General information, not professional advice. Rules in India change. Check anything important against the current position or a qualified professional. See the disclaimer.