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A step up for borrowing

A step-up home loan allows the repayment schedule to be adjusted according to the expected increase in a borrower’s annual salary.

What is a step-up home loan? How is it different from a normal home loan?
A step-up home loan allows the repayment schedule to be adjusted according to the expected increase in a borrower’s annual salary. In the case of a normal home loan, the repayment schedule is decided by the lender and is fixed for the entire tenure. It can be altered only if the lender changes interest rates.

How does it work?     
The step-up loan divides the loan term into two or three sub-periods. The EMI is less during the initial sub-periods and goes up with time, varying across sub-periods. The lender assumes a certain percentage hike in the salary of a borrower while calculating the EMI. For instance, if a person earning Rs 45,000 a month goes for a stepup home loan of Rs 20 lakh at 9.75% for 20 years, he has to fork out an EMI of Rs 18,000 for the first three years, Rs 21,000 for the next 10 years and Rs 13,976 for the remaining seven years after the lender factors in a 5% expected annual hike in salary (see table). The borrower can choose the EMI amount for upto two sub-periods, but must adhere to the EMI fixed by the lender in the initial years.

Is it better than a normal home loan?
Step-up loans not only help a borrower have a low cash outflow in the initial years, but more importantly, increase the loan amount, which may not be possible in case of a normal home loan. So a person earning Rs 45,000 per month will be eligible for a loan of Rs 18.96 lakh (approx) with a 20-year tenure under a normal home loan, but can avail of a Rs 20 lakh (approx) loan under a step-up plan.

Are there any eligibility criteria?
The loan is primarily for salaried individuals whose incomes have a good probability of rising due to the nature of their job and academic qualification. Government employees or self-employed individuals, whose income growth is irregular or inconsistent, do not qualify for this loan.

Are there any drawbacks?

It is a costlier loan as some lenders charge 1% higher rate of interest in the initial years. It is also easy for a borrower to fall into a debt trap if his salary does not rise as expected. You should go for such a loan only if the requirement is large and you are sure of a rise in your income.

 Loan amount (Rs)
Tenure (Yrs)
Rate of interest (%)
EMIs for first 3 yrs (Rs)
EMIs for next 10 yrs (Rs)
EMIs for rest of term (Rs)
Total cash flow
(Rs)

Normal home loan 20 lakh
20
9.75
18,980
18,980
18,980
4,55,5200
Step-up loan 20 lakh
20
9.75
18,000
21,000
13,976
4,34,1984
Difference in cash flow 
      1,13,216