Understanding the Increase in Monthly Mortgage Payments

Have you noticed that your mortgage payment is increasing each month? This can be a confusing and even concerning phenomenon. To help clarify this matter, we first need to understand the concept of an Equated Monthly Installment (EMI). Let's break it down with an example.

EMI Concept

A common example can illustrate how an EMI is structured and why it changes. Consider a home loan amount of Rs. 300,000 with a loan term of 10 years and an interest rate of 9%. This means your monthly EMI would be Rs. 3,800.

Loan Summary

Loan Amount: Rs. 300,000 Interest Payable: Rs. 156,033 Total Payable: Rs. 456,033

As shown in the chart, if the loan is continued for 120 months (10 years) via regular EMI payments, the total interest paid would be Rs. 156,033. However, in the loan account, only Rs. 300,000 appears, not the full amount of Rs. 456,033.

EMI Composition

When you make your first EMI payment, the outstanding balance on your loan account would increase by the interest accrued for one month, Rs. 30,225.00. However, once the EMI is remitted, the outstanding balance decreases by Rs. 3,800. This means that Rs. 2,250 goes towards the interest, and Rs. 1,550 goes towards the principal.

This example illustrates that each EMI is dedicated to paying off the interest first, and any remaining portion is applied towards reducing the principal. The balance outstanding each month is the remaining liability plus any interest not yet charged.

Fixed vs. Floating Interest Rates

EMI fluctuation can also be attributed to changes in the interest rate. There are two types of interest rates: fixed and floating.

Fixed Interest Rate

A fixed interest rate means that the interest rate applied for the entire loan period remains unchanged, irrespective of fluctuations in the market interest rate. This type of loan is more suitable for individuals who want to minimize monthly payments regardless of any economic volatility. However, because the lender bears the risk of fluctuating interest rates, the fixed interest rate is usually higher than the floating interest rate, with an additional percentage to cover any risk.

Floating Interest Rate

With a floating interest rate, the interest rate can adjust based on market conditions. This can be advantageous if you expect interest rates to drop in the future, as your monthly payments will benefit from these reductions. Conversely, if economic conditions change unexpectedly, such as during a period like the COVID-19 pandemic, you may experience higher payments.

It's important to note that while a fixed interest rate is advertised as a fixed rate, it is not truly fixed throughout the entire loan period. For long-term loans like home loans, the fixed rate applies only for a specific number of years, typically determined by the lender's policy, after which the loan reverts to a floating rate.

Base Rate and Floating Element

When a floating interest rate is applicable, a lender sets a base rate that corresponds to market conditions and a floating element based on the sanction ticket. The base rate can change according to market conditions, either increasing or decreasing. This floating element is then added to the base rate to determine the current interest rate for that month.

Impact on EMI

Any changes in the interest rate can cause the EMIs to fluctuate. If the economic conditions indicate a rise in interest rates, the EMI will increase. Conversely, in a favorable economic period with declining interest rates, the EMI will decrease.

Conclusion

Your mortgage payment increasing or decreasing each month is a natural result of the EMI structure and the market conditions that affect interest rates. Understanding these factors can help you make informed decisions about the type of mortgage that best suits your financial situation. Whether you prefer a fixed rate or floating rate, always carefully consider the long-term implications of your choice.