Step-Up Loans – Stepup Repayment Scheme for Home Loans

step-up-home-loanIndian retail housing loan market has changed a lot in last few years. Lenders and banks are bringing innovative home loan solutions to suit every individual borrower’s need and helping them to choose the loan repayment option as per his paying capacities.

One such innovation is the Step-Up Loan repayment facility, which allows you to pay lower EMI’s in the initial years and increase them later, when your incomes levels rise and you are in a position to afford higher payments for servicing your loans.

There can essentially be two type of Step-Up Home Loans based upon the purpose.

  • Type 1: In such type of loans, the purpose of stepping up the EMI is to reduce the loan tenure. The EMI paid in the initial years is same as the regular EMI. The increased EMI’s at later stages, when your salaries and incomes levels rise, ensures that your loan is quickly repaid and your overall interest outgo is reduced.
  • Type 2: The purpose here is to increase your loan eligibility. The purpose of stepping up is to ensure that you are required to pay a lesser EMI in the initial years as compared to the regular EMI. This shortfall is compensated by paying higher EMI’s at later stages. (Related: Home Loan Eligibility – How Banks Calculate Loan Eligibility Amount).

Let us elaborate them in more details with examples.

Type – 1 Step Up Home Loan – Purpose is to Reduce Loan Tenure

XYZ is a premium financier providing home loans to thousands of Indians. They offer a home loan scheme with step-up repayment facility, where the EMI amount is increased by a definite step two times during the loan period – on the beginning of year 6 and on the beginning of year 11. You are given a choice to opt for any of the step up rate 5%, 10%, 15% or 20%.

The calculations are as given below for a hypothetical case with following assumptions.

  • Loan Amount = Rs. 10,00,000
  • Annualized interest Rate = 10%
  • Loan Period = 15 Months
  • Step up Intervals – Two times in the entire loan period. After completion of 60 months and 120 months. This means that your EMI will remain constant for first 60 months. Then it will increase by the step up rate you choose for the next 60 months. After this 120 months, the Emi will again increase by the step up rate and then will remain same for the rest of the loan period.
  • Step up Rate options – You can choose anything among 5%, 10%, 15% or 20%.

If we calculate the total interest paid without exercising the step up option, we find that the total loan is repaid in scheduled 180 installments and the total interest outgo is Rs.  9,34,289. Now let us consider 4 scenarios for illustration purpose.

5% Step Up: The initial EMI comes out to be Rs. 10,746. This increases by 5% to Rs. 11,283 for the next 5 years i.e. from the beginning of year 6 to the end of year 10. This again increases by 5% to Rs. 11,848 for the remaining period of the loan duration.

This step up of 5% in the EMI ensures that you are able to repay your entire loan by the end of 168 installments, instead of schedules 180 installments. And your total interest outgo is Rs. 8,85,751 resulting in a saving of Rs. 48,538.

10% Step Up: The initial EMI comes out to be same as earlier i.e. Rs. 10,746. This increases by 10% to Rs. 11,881 for the next 5 years i.e. from the beginning of year 6 to the end of year 10. This again increases by 10% to Rs. 13,003 for the remaining period of the loan duration.

This step up of 10% in the EMI ensures that you are able to repay your entire loan by the end of 158 installments, instead of schedules 180 installments. And your total interest outgo is Rs. 8,48,396 resulting in a saving of Rs. 85,893.

15% Step Up: The initial EMI comes out to be same as earlier i.e. Rs. 10,746. This increases by 15% to Rs. 12,358for the next 5 years i.e. from the beginning of year 6 to the end of year 10. This again increases by 15% to Rs. 14,212 for the remaining period of the loan duration.

This step up of 15% in the EMI ensures that you are able to repay your entire loan by the end of 158 installments, instead of schedules 151 installments. And your total interest outgo is Rs. 8,18,629 resulting in a saving of Rs. 1,15,660.

20% Step Up: The initial EMI comes out to be same as earlier i.e. Rs. 10,746. This increases by 20% to Rs. 12,895 for the next 5 years i.e. from the beginning of year 6 to the end of year 10. This again increases by 20% to Rs. 15,474 for the remaining period of the loan duration.

This step up of 20% in the EMI ensures that you are able to repay your entire loan by the end of 158 installments, instead of schedules 180 installments. And your total interest outgo is Rs. 7,94,186  resulting in a saving of Rs. 1,40,103.

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Type -2 Step Up Home Loan – The Purpose is to Increase Home Loan Eligibility

As already mentioned earlier, the purpose of stepping up of EMI in such type of loans is to ensure that you are required to pay a lesser EMI in the initial years as compared to the regular EMI. This shortfall is compensated by paying higher EMI’s at later stages.

The lower initial EMI’s in the initial years essentially mean that the major part of the initial EMI’s is used up only to serve the interest dues and there is very little left for principal repayment.  This results in very slow rate of reduction in the outstanding loan balance and ultimately higher total interest outgo from your pocket. You should choose this option only when you are looking to get a higher loan from the lender, which you may not afford in a regular (without step-up facility) with your current income levels.

A key risk in this type of step-up home loan repayment schedule is the future volatility in the interest rate. Nobody can accurately predict the economic cycles and so, you cannot determine when the interest rate cycle start moving in northward direction. If this happens abruptly, this might significantly increase your EMI’s in future, which you may not be able to sustain. You should factor this aspect, while choosing step-up loan option with a purpose of increasing your loan eligibility.

Because of this inherent risk involved, Type-2 Step Up Home loans are generally not offered to business men. They are provided to salaried persons and professionals, whose income levels are expected to grow over a period of time in a more predictable manner. Within that segment also, this loan is more suitable for borrowers of younger generations, who might safely expect their incomes to rise quickly in near future.

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Lots of approximations and assumptions have been made while developing the calculators.

Please make your own calculations before making any financial decision.