Introduction

The recent amendment in the equated monthly instalment (EMI) of your loan by the bank has raised concerns. Is this increase justified? To answer this question, we need to delve into the different scenarios and conditions that can justify such a change.

Loan EMIs and MCLR

When the bank increases your loan EMI, it is often linked to the Marginal Cost of Funds-based Lending Rate (MCLR). MCLR is a new benchmark rate introduced by banks in India after the Reserve Bank of India (RBI) mandated the move to make the process more transparent. If your loan’s rate of interest (ROI) is fixed for the entire tenure, there will not be any variation in your EMI. This change is typically mentioned in the sanction letter provided by the bank.

The Role of the Customer Manager (CM)

Your query appears to be incomplete as it fails to mention the specific type of loan for which the EMI has been changed. Banks can only alter the rate of interest (ROI) or EMI amount after informing the Customer Manager (CM). Therefore, you may have received a letter from the bank that mentions a potential change in the ROI or EMI amount. For instance, if you have a Home Loan with an 8% ROI and your initial EMI was Rs 8,000 per month, a change in ROI to 9% could increase your EMI to cover the additional interest outgo.

Understanding EMI Changes

The increase in EMI can occur under two primary conditions:

Step-Up Clause

Loan agreements with a step-up clause allow for a lower initial EMI, which increases over time as the borrower’s income rises. This is a common strategy to accommodate varying financial situations over the loan period.

Interest Rate Fluctuations

When interest rates rise, the EMI might not be sufficient to cover the entirety of the interest amount. EMI is structured to cover both the interest and a portion of the principal amount, ensuring gradual repayment over time. If the interest rates increase and the current EMI does not sufficiently cover the interest outgo, it could lead to ldquo;negative amortizationrdquo;—a situation where the loan balance increases instead of decreasing. To prevent this, banks increase the EMI.

Amortization Process

The typical process of amortization involves gradual reductions in both the principal and interest components of the loan. However, if interest rates rise sharply, the borrower may end up paying only interest, leading to perpetual interest payments without reducing the principal, which can extend the loan term indefinitely.

Conclusion

Banks have the authority to increase EMIs under certain conditions, most notably if interest rates rise. It is essential to communicate with the bank to understand the specific reasons for the EMI change and ensure that you are aware of any potential financial implications. While such changes can be challenging, they reflect broader market conditions and regulatory requirements.