In the event of Covid19 crisis and the subsequent lockdown, the RBI announced a three-month moratorium on loan repayments 2 months ago. Anyone having a loan with banks and NBFCs could avail this benefit and did not have to make any repayments for the months of March, April and May. Now this relief has been further extended by the RBI till August. 2020
The objective is to provide relief to those borrowers who could be facing a liquidity crunch due to the lockdown impact on jobs and business income. This benefit is for all types of term loans including home loan, auto loan, personal loan, educational loans, credit card dues, etc.
Why you should avoid it?
Firstly, a moratorium period is a time when borrower is not required to make any payment. So, this doesn’t imply waiver of interest as is commonly misunderstood by many borrowers. The idea of a moratorium isn’t to give you interest free period, it is to help with the cash flow. Banks will in fact continue to charge interest under the moratorium period even though you do not make any payments. Although you get immediate short-term relief, the outstanding interest will be added to your EMIs at the end of the moratorium period thereby raising your effective cash outflow. This unpaid interest will either be adjusted in a higher EMI or a longer repayment tenure. Either ways, you will actually end up paying more interest.
To illustrate, let us assume you have taken a home loan of Rs.50 lakh at 8.5 per cent interest for 20 years (Refer to the table below). This translates into an EMI of Rs.43391. For simplicity purpose, let us assume your first instalment starts in June. But you opt for the moratorium. The principal loan of Rs.50,00,000 will however attract interest at 8.5 per cent which comes to Rs.35,417. So, your outstanding loan amount at the end of April stands at Rs.50,35,417. Again, you do not pay EMI in May. Interest will be applicable on the full amount of Rs.50,35,417. At the end of three months, your outstanding loan amount will be Rs.50,71,084. Effectively, you will be paying an extra Rs.1.07 lakh interest to the bank. If it gets adjusted in EMI, your new EMI that will payable from September will be Rs.44,320 as against the original Rs.43,391. If it gets adjusted in the tenure, then your total loan tenure will get extended by another 9 months to 20.9 years as against 20 years.
Moratorium option – Your last resort.
The RBI has cut the benchmark repo rate in the past few months with a view to ease liquidity pressure. If you have a floating rate loan, you can negotiate with you bank for a lower home loan rate. Lower EMIs would be a relief in these times. But if your earnings and liquidity are affected that you cannot service your EMIs out of it, evaluate other ways to arrange the money. Review your emergency fund and check if it would be sufficient to repay EMI from that. You can also consider liquidating your fixed deposits or redeeming some of your investments. Although it is usually not advisable to dip into investments which may be mapped to some financial goals, tough times call for tough measures. It is better to dip into your savings rather than paying heavy interest on loans. Seek financial help if possible, from your trustworthy relatives/friends whom you can candidly and honestly approach for a loan. If you exhaust all these options and you feel your EMI obligation is big enough, then go for the moratorium option.
But it is important to understand the eventual impact of the loan moratorium on your cash flows first. Be mindful of the additional interest which will accumulate at the end of the moratorium period and see if you can pay it back in addition to your regular EMI. Figure out a plan to prepay the additional interest soon after the moratorium ends.
Remember, there are no free lunches in this world!