[Decoded] What should be the ideal length of your mortgage loan? | Photo credit: BCCL
With mortgage rates at an all-time low, this is probably the best time to buy a home. Home loans make home ownership convenient and affordable. If you have decided to buy a property by taking the help of a home loan, there are several crucial factors that you should keep in mind. Besides the loan amount, interest rates, Equivalent Monthly Payments (EMI), an important factor that you need to consider is the length of the loan. The tenure periods for mortgage loans are generally between 5 and 30 years. You pay your IMEs during this time.
While a longer mortgage term of 20 to 30 years reduces EMI expenses, it requires a larger interest payment. A shorter loan term increases the EMI obligation but reduces the total amount of interest paid over the life of the loan. Thus, a longer tenure period results in lower EMIs than a mortgage with a shorter tenure period.
Here are four key elements that will help you choose the ideal length of your mortgage.
The term of a home loan is generally synchronized with the age of the borrower. So if you are in your 20s or early 30s and just starting your career, going for a 20-30 year term will help you manage growing financial responsibilities. Managing your regular expenses with a smaller IME may be easier for you. You can only go for a shorter term home loan at this point in your career when you are financially strong and able to support the load of a large IME. If you are nearing 40 or about to retire, it is advisable to opt for a shorter loan term to meet the bank’s eligibility standards.
Usually, the maximum loan term is capped by the lender at 30 years. Some can be up to 35 or even 40 years old. However, seniority takes into account the age at which the borrower will retire. So, for example, a 25-year-old is considering retiring at age 60 and may try to get a 35-year term. On the other hand, if you have 10 years to retire, this might be the maximum time you can get. Exceptions can be made for government employees who are in receipt of a pension and can comfortably pay their IMEs even in retirement.
Amount of your loan
A higher loan requirement means a higher EMI obligation. You need to decide on the length of the loan taking into account your current income. For example, if your loan is about two to three times your annual income, you can opt for a shorter term to avoid unnecessary additional interest expense. But if the loan is larger, a longer term may be preferable to avoid strain on your finances.
Existing debt securities
You need to take into account existing debts such as personal loans, car loans, credit card bills, gold loans, etc. Although having more than one existing debt decreases the borrowing capacity of the loan to this extent, so to increase the lending capacity you have two options. The first option is to close your existing debts if you want to qualify for a short term loan. The second option is to apply for a longer term loan while continuing with the other loans. You may decide to close your existing loan based on your cash flow or your current financial situation.
Make a final decision
Your priority should be to reduce the risk of loan default as much as possible. You can reduce the risk of default by borrowing within your financial capacity. When estimating your financial capacity, you should take into account your current and future income, other financial goals, long-term income stability, etc. A home loan is one of the cheapest borrowing tools that also offers several tax advantages.
If you want to get rid of your debts quickly and have no liquidity constraints, you can opt for a short or medium term mortgage. On the other hand, if you want to take advantage of the tax advantages of home loans as well as lower-cost financing and have a limited debt repayment capacity, you can opt for a longer-term home loan. And during tenure, if you ever have the option of prepaying your loan, go ahead and take the opportunity to free yourself from your debt.
Adhil Shetty is a guest contributor. The opinions expressed are personal.