It’s very natural to avoid paying higher EMIs if you have a chance to pay lower ones. Isn’t it? After all, who wants to have the additional burden of paying larger EMIs for loans that run for years?
But going for lower EMI might not be a financially prudent choice. Let us try to understand why it is so.
When interest rates fall across the market, the banks and lenders can choose to pass on the benefit of rate cut to existing borrowers (new ones automatically benefit from fresh lower rates). So at times, the lenders give existing borrowers a choice between reducing EMI (by keeping the tenor same) and reducing the tenor (by keeping the EMI same).
Now if you do the calculations using personal loan EMI calculator, you will realize that as the loan tenure increases, more money has to be paid towards interest component. On the contrary, when tenor is shorter, a higher part of the EMI is used for paying back principal every month. Since interest is calculated on the outstanding principal, faster principal repayment leads to lower absolute interest payout.
Here is a simple example to help you better understand this
Suppose you take a Rs 5 lac. personal loan. You have the option of taking either of a 3-year tenor or 4-year tenor. So what should you do? The answer lies in next two lines:
EMI for 3 years – Rs 17,333 (Total Interest Paid – Rs 1.23 lacs)
EMI for 4 years – Rs 13,915 (Total Interest Paid – Rs 1.68 lacs)
Though lower EMIs might look attractive in the short term, you will end up losing more than Rs 45,000 by taking that one year extra loan tenor.
A similar case will play out if your interest rate changes in between your tenor and you have the option of either taking a lower EMI or lower tenor. This is the reason why it is advised to not lower your EMIs after rate cuts. By paying the old (higher) EMIs, you reduce the loan tenure as well as the total interest that you pay during the course of loan.