Reserve Bank of India

banks

moratorium

EMI

loan

State Bank of India

SBI

tenure

On March 27, the(RBI) put out a notification permittingand non-banking finance companies (NBFCs) “to grant aof three months on payment of all instalments” of term loans “falling due between March 1, 2020 and May 31, 2020”.This got the media, in particular the Indian languages media, all excited. But the devil as usual lay in the detail.The RBI notification made it very clear that only if the individual bank or NBFC wanted, did it need to offer a moratorium. From the details available as of now, all banks and NBFCs are offering this facility to their borrowers.In case of most banks and NBFCs, the borrower has to apply for the moratorium and unless that is done, the regular(equated monthly instalment) on thewill be debited from the bank account. The details of how to go about this are available on the individual websites of banks and NBFCs.If you apply for a moratorium it will come with a certain cost attached to it. Let’s try and understand this through an example which is doing the rounds on the social media. The) on its website says: “Impact in case of Home Loan – For a loan of Rs 30 lakhs with a remaining maturity of 15 years, the net additional interest would be approximately Rs 2.34 lakhs equal to 8 EMIs.”Let’s understand this in detail. Let’s say you have taken on a home loan from SBI. The outstanding amount on the home loan is Rs 30 lakhs. Theremaining is 15 years (or 180 months) and the rate of interest being charged is 8.35% (this detail is not there on the SBI website, but something I have assumed).The EMI on this home loan will amount to Rs 29,279. Let’s say you decide to make use of the moratorium. In this case, you will not pay any EMI until May 31. Also, if you have already paid an EMI for the month of March, it will be credited back to your account.At the same time an interest will be charged on the outstanding loan for the period of three months you do not pay any EMIs. At 8.35% on a loan of Rs 30 lakh, this amounts to Rs 62,625 in total. This will be added to your outstanding loan of Rs 30 lakh. In June 2020, when the moratorium ends, the outstanding loan will become Rs 30,62,625. The EMI will continue to remain the same at Rs 29,279. As you repay a higher outstanding loan with the same EMI, the tenure of the loan will go up.In this case, the tenure will go up by 8 instalments(7.7 to be very precise) and the outstanding loan will now be repaid over a period of 15 year 8 months. The extra eight instalments in total amount to around Rs 2.34 lakh.The question is why is this happening i.e. why does the tenure end up growing by 8 months? The reason is very straightforward. By not paying the interest for three months and adding it to the outstanding loan amount, you end up paying interest on interest and that leads to an increase in tenure.In fact, the tenure increases by 8 months irrespective of the outstanding loan amount as long as the outstanding tenure is 15 years and the interest rate is 8.35%. The longer the remaining tenure of your loan, the higher will be the increase in tenure if you opt for the moratorium.Let’s take the other example on the SBI website: “Impact in case of Auto Loan – For a loan of Rs 6 lakhs with a remaining maturity of 54 months, the additional interest payable would be … equal to additional 1.5 EMIs.”The EMI on such a loan at an interest of 9% amounts to Rs 13,554. If you opt for a moratorium, the interest for a period of three months will amount to Rs 13,500. In June 2020, this will push the outstanding amount to Rs 6,13,500. At an EMI of Rs 13,554, the remaining tenure now will be 55.5 months or 1.5 months extra from the original tenure.If outstanding tenures are low, the extra tenure will also be low.The moral of the story is that you should continue paying the EMIs and making use of the moratorium should be the last option you choose.Some people are wondering as to why do banks need to charge an interest for the moratorium period. This is as simple as it gets. Banks borrow from people who have money and lend to people who need it. People who deposit money in a bank are paid a certain rate of interest. Banks pay interest by charging an interest on their loans. If interest on the loans of banks are not repaid, how will the bank ever get around to paying interest on their deposits?Everyone who is suggesting that the banks should not charge an interest under the moratorium need to think about this very basic problem.