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Photo: Bloomberg
Photo: Bloomberg

Flexible EMI repayment options may burn a hole in your pocket

Under such schemes, you may get to pay lower EMIs for some time, but the total interest outgo is higher

As workplaces reopen as Unlock 1.0 unfolds, people would prefer using their your own car for the office commute to avoid the risk of contact as social distancing becomes the new normal in the wake of covid-19. In such a situation, a lot of people may need to buy their first cars or even a second car for a working spouse. But given the recent pay cuts, it may not be easy for everyone to afford a regular equated monthly instalment (EMI) against a car loan.

“Due to the pandemic, those who are resuming work, want to travel by the vehicle they own instead of taking a public transport or app-based taxis," said Aditya Mishra, founder and CEO, Switchme.in, a platform that helps borrowers shift their home loans to other financial institutions.

In order to tap this market, Maruti Suzuki India Ltd, the country’s largest carmaker, has partnered with HDFC Bank Ltd to offer flexible EMI options to new car buyers.

The flexible loan repayment structures may work for those who have seen pay cuts and expect their salaries to get restored once things normalize and the lockdown is completely lifted. Once their salaries are restored, they would be able in a position to pay regular EMIs.

The options

The bank is offering three repayment options to borrowers who could be facing a cash crunch.

Of the three schemes, two focus on lower EMIs in the initial months. The first scheme combines step-up and balloon payment under which, initially, the EMIs are lower and go up later during the tenure. Under HDFC Bank’s scheme, the initial EMI is as low as 1,111 per 1 lakh for a loan tenure of 84 months.

Graphic: Paras Jain/Mint
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Graphic: Paras Jain/Mint


The second option allows the borrowers to pay lower EMIs for the first six months (for salaried) or three months (for self-employed). In this case, the EMI starts at 899. The third is a flexi EMI scheme, where the borrower can choose lower EMIs for three months every year for the entire tenure of the loan.

These structures also increase the eligibility of the borrowers as the initial EMI is lower, based on which the loan amount is decided.

HIGHER PAYOUT

The flexible repayment structures come with a cost. “They are similar to a moratorium a borrower avails of on a loan. When there is no payment or lower payment for some months, the interest portion is added to the principal and interest is charged on it. The total outgo, therefore, increases," said Deepesh Raghaw, founder, PersonalFinancePlan, a Sebi-registered investment adviser.

Under the step-up option that various banks are offering, the EMI is lower for some part of the initial tenure of the loan, and later it increases. Lenders, typically, target young professionals for these loans, considering their future earning potential, which also allows them to take a higher loan amount. Suppose a borrower takes a loan of 7 lakh and pay an EMI of 8,000 for the first three years, and 14,603 for the next four years. Here the borrower will end up paying 42,920 extra in total interest outgo as compared to a regular EMI (see graph).

Under the balloon repayment structure, the borrower pays lower EMI initially and makes a large lump sum payment towards the end of the loan. It is among repayment methods where the interest outgo is far higher compared with other structures of repayment. “Balloon works for those who get bonuses every year, and can make a large payment at one go," said Gaurav Gupta, CEO, MyLoanCare, an online loan marketplace.

A combination of step-up and balloon can be difficult for borrowers to analyze. It also results in a higher outgo at a later stage.

What should you do?

Every benefit has a cost involved. If your cash flows are unaffected by the pandemic, it’s best to stick to the regular repayment method.

Flexible structures may work for you only if you are certain that your income will be restored in some months. However, there have been layoffs and there is a lot of uncertainty on the impact of the lockdown on businesses and the economy. “In case there is uncertainty, borrowers should completely avoid taking any new liability," said Raghaw.

“Low EMI for three months work for those who have a higher outgo in some months such as March and April, where people make tax-related investments and pay school fees," said Gupta.

If you think it works for you, don’t forget to ask for a loan schedule and see whether your cash flows can meet the requirements. Also, negotiate for a discount on a car and see if that works better for you.

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