What Does My Loan Moratorium Cost?

Why you should not avail it if you can afford to pay your EMIs

We are in the middle of a full-blown financial crisis caused by the novel coronavirus that had brought the entire globe to a screeching halt early this year. Though lock-down restrictions are gradually being relaxed across the world and people are slowly trickling back to workspaces, the damage caused by the lack of economic activity during the past few months and the sub-optimal economic activity expected to happen in the coming months will be significant to recover from.

To ease the burden on the general public, businesses and corporates, Financial Regulators and Central Governments of various countries have come out with a plethora of relief packages — ranging from unemployment allowances to loan repayment reliefs like forbearance protection. In this post, we shall talk about one such intervention by the Reserve Bank of India (RBI), the Financial Regulator of India — loan moratoriums.

To answer this, we need to understand how EMIs are computed.

Theoretically, there are 2 ways in which EMIs can be computed.

In general, the loans offered by Banks compute EMI using the reducing balance method.

The key to understanding the cost of Loan moratorium is this:

When you avail a loan moratorium, you do not have to pay your monthly instalment during the moratorium period. But, at the same time, the interest continues to be charged.

The principal that you are failing to pay back during the moratorium leads to higher interest accrual.

Some of us are not aware that the interest continues to get charged during the moratorium, while the rest of us are aware but do not understand how costly it is.

To illustrate the impact, let us assume a home loan of INR 50 lakhs with a 10 year tenure at 9% annual interest rate.

The EMI is computed to be INR 63,338

To understand the impact of a moratorium for a given moratorium period, we need to know how much of the principal is yet to be paid. So, let us assume that 12 months of EMI are already paid and you are availing the moratorium for 6 months.

There are 2 options that Banks provide to incorporate the moratorium in your loan repayment schedule:

Option 1: Increase your EMI — so that you can pay back the loan within the original loan tenure

Impact: You will be paying an additional interest of more than INR 3 lakhs (12% higher than the original interest payable)

Now, let’s look at the other option.

Option 2: Increase your loan tenure — so that you can continue to pay the same EMI

Impact: You will be paying an additional interest of more than INR 5 lakhs over 8 more months (19% higher than the original interest payable)

While loan restructuring is an important feature that enables people and businesses to avoid defaulting on loans and to stay afloat, it is paramount to see the whole picture before taking that step.

To conclude:

It is for times like these that we need to build and maintain an emergency fund that can be dipped into. You can read about setting up your emergency fund and other personal finance practices here.

And let’s remember this,

Have a good life. :)

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