Extension of moratorium on loans: Piling up of problems

The apex bank of India is considering the further postponement of the moratorium on home loans by three months, owing to the extension of nationwide lockdown by more than one month. Earlier on March 27, RBI allowed banks and financial institutions to offer a moratorium of three months on payment of instalments on all term loans outstanding as on March 1. This was done to help people and industry impacted by the ongoing lockdown, which was necessitated to hold the spread of Coronavirus.   

On the surface, the moratorium seems very much borrower-friendly, as it allows them to defer the equated monthly instalment (EMI) payments by three months. Nevertheless, readers and borrowers should understand that it is only going to increase their burden going ahead.

For example, if you have availed a loan of Rs 20 lakh for 20 years and the rate of interest being charged to you is 8.7 per cent and suppose your EMI started on January 01, 2020; under this assumption, your EMI comes at Rs 17,610.46. And, by the end of 20 years, you will have to pay Rs 42,26,510 out of which, interest amount would be Rs 22.26 lakh.

Now, if you defer the payment for three months, you not only have to pay the interest on your principal amount for a longer period but also, your principal amount will increase by the accrued interest amount.  In the above example, if you defer EMI payment by three months, depending upon the loan tenure, your payment or loan tenure will increase accordingly. For example, if you had paid first eight instalments and then defer your three EMI payments, your loan tenure will increase by 14 months. So normally, your EMI payment would have ended on December 2039 but now, it will end on April 2040. So now, you will have to pay Rs 1,93,710 (Rs 17,610.46*(14-3)) extra.  

Nevertheless, the impact of the deferment of payment will be less, if you made most of the payment. For example, in case you have already paid 10 years of EMI, three months of loan deferment means that you will pay Rs 1,27,116 extra.

Now, some smart investors will try to take benefit of this deferment and pay the accumulated amount at the end of three months that will knock down some of its principal which means, lower interest payment later. Our calculation shows that it is a zero-sum game as the extra payment from the principal will only reduce the accumulated interest and a little bit of principal. Therefore, it is recommended that you continue to pay the EMI.  

We believe that the extension of the moratorium will only aggravate the situation for the borrowers, especially for those whose are nearing their retirement. This also raises risk for the banks, as it may lead to higher NPAs, going forward. Therefore, it will be better for RBI not to kick the can down the road.