Step-up scheme for young borrowers

[Cognitive]

Step-up scheme for young borrowers

The repayment of a home loan is through equated monthly instalments (EMIs). Some banks provide the step-up EMI facility to borrowers.

The step-up EMI facility reduces the repayment burden in the initial years and helps in increasing the loan eligibility of the applicant. It helps young borrowers, especially those who intend to borrow early but do not have a high income and cannot afford higher EMIs in the initial years.

Later, over time, as the income increases, they can afford to pay higher EMIs. In this process, the borrower takes on a higher interest rate risk if the loan is based on a floating rate of interest. A rise in the interest rate would mean a portion of the total interest would remain unrealised and added to the borrower's principal.

Since a large part of the initial instalments go towards interest payment, the borrower can avail of tax benefits for a longer period. Interest on the loan is a cost. However, the tax benefits reduce the cost of borrowing. This way, the borrower can deploy his savings into other investments schemes that offer a better rate of return.


courtesy: ET

[Cognitive]

In this scheme, the EMI portion is recovered in parts. During the first few years, a lower EMI amount is to be paid by the borrower.

During the latter part of the loan tenure, EMIs are increased, so that a higher EMI amount is payable during the later years. This way, the burden of repayment in the initial years is reduced for the borrower.

The lower EMI is made possible because of the step-up facility where the monthly payouts increase during the later part of the loan tenure.

The principal repayment under a step-up loan may start immediately, thereby reducing the interest rate risk for the borrower. In other cases, the EMIs for the first few years are just enough to cover the current interest rate.

The process of step-up can be in different phases. In some cases, two phases are offered - one at a lower rate and the other at a higher rate. In other cases, the step-up can be a gradual process. It can be done yearly or every five years, or at some other time periods.

Some banks also offer the step-up scheme with a fixed interest rate, but the rate of interest for such loans is higher than the floating rate. Borrowers need to remember, in a step-up scheme, the interest rate risk exposure is quite high. In the initial years, the interest component is more and the principal component is lesser.