The repayment of housing loans is through equated monthly instalments (EMIs). Some banks provide an accelerating or step-up EMI facility to borrowers. The step-up EMI facility intends to reduce the repayment burden in the initial years and helps in increasing the loan eligibility of the borrower. The facility helps young borrowers particularly. They prefer borrowing early but at the same time do not have high incomes and can't afford higher EMIs in the initial years. However, over time, as their income increases, they can afford to pay higher EMIs.

In this facility, the EMI portion is recovered in parts. During the first few years, a lower EMI is to be paid by the borrower. During the latter part of the loan tenure, the EMIs are increased, so that a higher EMI is payable during the later years. This way the burden of repayment in the initial years is reduced for the borrower.

The step-up facility involves a lower outgo in the initial periods. Borrowers who are likely to earn more in future can avail this facility to get higher loans and adjust their cash flows over a period of time. In this process, the borrower takes on a higher interest rate risk if the loan is based on a floating rate of interest. A rise in rates would mean that a portion of the interest would remain unrealised and added to the borrower's principal.

Since a large part of the initial instalments go towards interest payments, the borrower can avail of tax benefits for a longer period. Interest on the loan is a cost. However, tax benefits reduce the cost of borrowing. This way the borrower can deploy his savings in other investment schemes.

The principal repayment under the step-up loan may start immediately, thereby reducing the interest rate risk for the borrower. In other cases, the EMIs for the first few years are just enough to cover the current interest rate. The process of step-up can be in different phases. In some cases, two phases are offered - one at a lower rate and the other at a higher rate. In other cases, the step-up can be a gradual process. It can be done yearly, every five years or some other frequency. Some banks also offer the step-up facility with a fixed interest rate, but the rate of interest on such loans is higher than that on a floating rate loan.

The borrowers need to understand that in the step-up facility, the interest rate risk exposure is quite high. In the initial years, the interest component is more and the principal component is less - lower EMIs in the initial years would mean that lesser of the principal is being repaid. This deferral of principal to the later part of the loan tenure will increase the interest cost of the loan. This may turn out to be costly in case of a floating rate loan where the interest rate increases. The higher interest rate would have to be paid on a higher outstanding principal loan amount. In case of a rise in interest rates, the difference is recovered through higher EMIs towards the end of the loan tenure.