Why opting for 3-month loan moratorium is injurious to your financial health

Lenders are offering loan moratorium, but opting for this will make you pay a lot more interest later. EMI pause if you must, better to seek informal loans from friends or family to manage the crisis

Kumar Shankar Roy Apr 3, 2020

external benchmarking for loansReserve Bank of India has allowed banks to offer a 3-month EMI moratorium scheme. Banks have started operationalising the scheme too. Most of the banks want the customers to contact them to take advantage of the moratorium. The question is do you as an individual really should opt for the moratorium scheme? Remember, this is an EMI moratorium, and not a principal or interest waiver.

Our view is opting for the EMI moratorium is injurious to your financial health. Why? Because lenders will continue to charge interest during the moratorium period, in effect increasing your outstanding loan principal amount. This means if you opt for the EMI moratorium, you will be paying much more later. So, this moratorium scheme is not a free EMI pause facility. It comes with attached costs, which we will explain below. Unless your cash flow situation is really bad and only if you are not able to pay EMIs, then only you should think about opting for the moratorium. If you have an option to seek informal loans from friends and family, then we will even recommend taking that route. All told, opting for loan moratorium should be your very last solution.

How EMI math works

Every borrower who takes a home loan, car loan, or an education loan (some term loan examples), he pays back the principal and the interest over the loan tenure on a monthly basis which is called equated monthly instalment or EMI. The monthly EMI contains a principal component and an interest component. Both these numbers are combined to make one single number: Your EMI.

For example, if you take Rs 25 lakh home loan at 8.3% for 20 years, you will over 20 years repay Rs 51.31 lakh (Rs 25 lakh principal and Rs 26.31 lakh interest). Hence, your monthly EMI is Rs 51.31 lakh divided by 240 months = Rs 21,380 (use our EMI calculator to see how it works). Typically at the start of the loan tenure, the interest repayment is at its highest. In the 1st year, you will pay total EMIs of Rs 2.56 lakh out of which interest is Rs 2.05 lakh and the principal is Rs 50,972. Over the years the interest component will go down while the principal repayment component will go up. The principal repayment component is highest at the end of the loan. So in the last year (20th) of EMI repayment of Rs 2.56 lakh, the interest component is just Rs 11,172 and the principal repayment component is Rs 2.45 lakh.

How EMI moratorium works

You were paying your EMIs on time before coronavirus slowdown struck hard. Your income has plunged. Your loan lender has offered you a 3-month EMI moratorium. This calendar year you paid EMIs on time, but now you face cashflow problem. You decide to take the EMI moratorium offer. In effect, you will not be paying EMI for 3 months. The lender says the EMIs will be recovered later. But, that’s not all. There’s a catch.

The lender is not giving you EMI moratorium for free. Since the RBI has allowed lenders to charge interest during the moratorium, your three unpaid EMIs will get added one after the other on your outstanding principal amount and interest will be charged onto them. This, in effect, makes it financially injurious. Why? Because you will end up paying interest on this additional principal, and because of that the number of EMIs you pay will be going up.

What is the cost of EMI moratorium?

The effect of charging interest upon the three paused EMIs, which are added to your outstanding loan amount, is quite large. For a Rs 50 lakh loan taken at 8.3% annual rate for 20 years, the effect can range from paying four months additional EMIs if you take the moratorium very late in your loan tenure, or as high as 17 months extra EMI if you take the moratorium very early in your loan tenure.

Let us explain with a small example. For the above-mentioned Rs 50 lakh loan, assume you have successfully paid 20 months of EMI so far. The EMI amount is Rs 42,760. Now you are taking the 3-month moratorium option. So, the balance tenure before the moratorium is 240 months minus 20 months = 220 months. Because you did not pay the EMIs and they get added progressively to the outstanding loan amount, you will have to pay total interest of Rs 57.45 lakh as against total interest without moratorium of Rs 52.62 lakh i.e. Rs 4.83 lakh more!

Take a look at the table below to check how your loan tenure gets longer if you opt for EMI moratorium. We have assumed your EMI remains constant because this keeps the monthly budget in check.

Hidden cost of 3 month EMI moratorium for Rs 50 lakh loan for 20 years

Outstanding loan Extra EMIs Excess interest
220 months 15 Rs 4.83 lakh
200 months 13 Rs 4.01 lakh
150 months 9 Rs 2.42 lakh
100 months 7 Rs 1.31 lakh
50 months 5 Rs 0.55 lakh
25 months 4 Rs 0.26 lakh

* loan interest is 8.3% and assuming EMI stays constant at Rs 42,760

After the moratorium, lenders can either offer to increase the number of EMIs, or they can keep the number of EMIs constant while increasing the amount per EMI. Either way, you have to pay more for this 3-month moratorium.

RupeeIQ take

By this point, it should be amply clear that the EMI moratorium costs. It can be a lot if you are opting for it early in your loan tenure, and a little less if you are opting for it late in your loan tenure. So, only go for EMI moratorium if you cannot pay the EMI.

Opt out of the EMI moratorium by writing (email/call) to the lender immediately. This is because some lenders are offering the moratorium as a default option, thereby ensuring you pay a lot more interest later if you opt for EMI pause. Get a confirmation from your lender on opting out.

Top banks usually charge lesser interest on home loans. NBFCs and housing finance companies charge a little bit more. The higher your loan rate, the extra additional EMIs in months you may have to pay. This is because comparatively higher interest will help balloon your outstanding loan much faster, than a loan with a lower interest rate.

Unless you are affected by the COVID-19 triggered economic slowdown and have no money to pay EMI, there is no benefit in opting for EMI moratorium.

If you don’t have money, try to seek informal loans from friends or family to manage each month’s EMI if you are unable to pay due to economic slowdown.

Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. Kumar is a financial journalist, with a functional experience of 15 years. He tracks mutual funds, insurance, pension, PMS, fixed income/debt and alternative investments markets closely. He has worked for The Times of India, The Hindu Business Line, Deccan Chronicle Group, DNA, and Value Research, among others, across different cities in India. He is deeply interested in marrying data insights with actionable opinion. He can be contacted at [email protected].

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