Longer repayment tenure or a higher EMI for personal loans?

Tue Oct 9, 2012 10:21am IST

Rithika, six years old, is tossed into the air by her father as they join devotees at the Arabian Sea on the fifth day of the ten-day-long Ganesh Chaturthi festival in Mumbai, September 23, 2012. REUTERS/Vivek Prakash/Files

Rithika, six years old, is tossed into the air by her father as they join devotees at the Arabian Sea on the fifth day of the ten-day-long Ganesh Chaturthi festival in Mumbai, September 23, 2012.

Credit: Reuters/Vivek Prakash/Files

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While looking for a good deal on a personal loan there is always the dichotomy of choosing between longer repayment tenure that makes the EMIs comfortable or shorter period that has a higher EMI but ultimately saves on interest paid out. There are several offers on personal loans that are being advertised and advocated by the various financiers.

Some banks offer a repayment period up to 7 years for a personal loan to customers who found it difficult to bear higher EMIs on bigger loan amounts. One needs to understand a few features of the personal loans and their implications on the net amount paid out in order to arrive at a correct decision in this regard that shall suit his requirement.

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Few Essential Facts for Understanding

Here are some essential facts that every personal loan borrower must keep in mind:

· It is the loan period compared against the loan amount that determines the EMI with the rate of interest factored into the calculation.

· The interest rates applicable for shorter tenure loans are lower compared to loans with longer repayment period.

· A personal loan with longer repayment tenure will invariably result in higher total amount of interest paid for that loan.

The Significance of the Repayment Tenure

The repayment tenure that is agreed upon by both the parties at the time of availing the personal loan is one of the most important factors that will determine the actual amount that is paid out by the end of repayment. This figure shall also determine the kind of interest rate regime that is applicable for that particular personal loan.

Most financiers charge lower rates for shorter duration loans and vice versa. Thus ultimately the repayment tenure will decide the total amount to be paid back and thereby directly influence the EMI which is applicable.

Thus any increase in the repayment period will have a twofold impact. Firstly the total interest increases as the interest is paid for a longer time. Secondly the total interest further increases as a higher rate of interest is now charged from the beginning.

Illustration:

If you take a personal loan of 1 lakh rupees with tenure of 3 years with an interest rate of 16 % then the EMI will be 3,515 rupees and the total interest paid in the end will be 26,565 rupees. But by increasing the tenure to a period of 7 years, the EMI will now become 1,986 rupees and the total interest paid will go up to 66,840 rupees. But by increasing the tenure the bank will increase the interest rate which if calculated at 18% will imply the total interest paid on the loan comes to 76,550 rupees in a period of 7 years.

However, before deciding on a shorter tenure one must keep in mind the ability to cope up with a higher EMI. In case one is not able to keep up with the high EMI then there is the problem of defaulting and thereby incurring high rates of penalties which will increase the burden further.

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