Understanding the Basics of EMIs
In the past, taking a home loan was difficult as not many banks and financial institutions offered the facility. Furthermore, those who did had lots of paperwork and processes to be completed. The cumbersome practices, lack of transparency and incomplete understanding often deterred potential home buyers from availing a home loan that suited them.
Today, thankfully, there is a shift in trend with more banks and financial institutions offering affordable home loans with simpler processes, so that more and more people can invest in property and realize their dreams. To serve the purpose in the best possible way, a home loan is broken up into smaller amounts so that the takers are not restrained by this huge financial commitment. These smaller chunks are called EMIs or Equated Monthly Instalments.
EQUATED MONTHLY INSTALMENTS OR EMI
A home loan is a certain amount borrowed from a bank or financial institution to purchase a house. This amount is broken up into EMIs or Equated Monthly Instalments. This is the fixed amount of money that a borrower pays to the bank or financial institution, every month, as part of the repayment towards the outstanding loan. This payment needs to be made on a specific date every calendar month and includes the principal and interest, discussed and agreed upon by both the parties. The EMI can be paid via cheque or any online mode or using the auto-debit facility.
For an individual who lives in a rented apartment and has booked a house in an under construction project, the Pre-EMI option is a blessing! Under this repayment scheme, the borrower will only be required to pay the interest portion of the amount, which is disbursed in tranches, until the time the house is ready and the entire amount is disbursed. This period in the Pre-EMI stage is known as the Moratorium Period. During this phase, pre-EMI interest (PEMI) is to be paid monthly till the final pay-out is done, after which the EMIs start.
A Tranche EMI option is the EMI calculated only on the Disbursed Amount. It permits the borrower to begin the repayment of the principal and interest amount only on the disbursed amount, instead of the complete loan in the regular EMI option.
HOME LOAN AMOUNT CALCULATION
Commonly known as the Principal Amount, the home loan amount is the total amount that an individual borrows from a bank or financial institution, based on which the EMI amount is decided.
Interest and Interest Rate
The interest is the amount that a borrower has to pay above the principal amount for availing the benefit of having ready financial support at his or her disposal. The interest rate is the rate at which the interest is calculated on the borrowed amount by the bank or financial institution. This amount is arrived at after various calculations, and an assessment of the borrower’s credit profile.
The tenure is the repayment time-frame agreed upon by the lender and the borrower. The longer the tenure, the more interest you will have to pay to the bank or financial institution.
The mathematical formula for calculating the EMI amount is: EMI = P × r × (1 + r) ^ n / ((1 + r) ^ n – 1) Here P = loan amount, r=rate of interest, n=loan tenure (in months). Thus, for instance, calculated in the simplest format, for a loan of 5 lakhs, the EMI would be Rs. 16, 607 at 12% interest and 36-month tenure.
Fixed Interest Rate
As the name signifies, with a Fixed Interest Rate, the interest rate will remain the same throughout the loan tenure and so will the EMI. Fixed interest rates are usually higher than Floating Interest Rates by 1% to 2%.
Floating or Variable Interest Rate
Floating or Variable Interest Rates are subject to change based on market trends, which are correlated to the rate below which the bank cannot lend, also known as the ‘Base Rate’. Thus, a change in the Base Rate would automatically change the rate of interest.
Marginal Cost of Funds-Based Lending Rate or MCLR
A new method of bank lending called ‘Marginal Cost of Funds-Based Lending Rate’ (MCLR) was put in place for all loans, including home loans, after April 1, 2016. While new borrowers after April 1, 2016, can only take MCLR-linked loans, the individuals on the base rate have the alternative to shift to MCLR. Under the MCLR approach, the banks have to evaluate and announce overnight, one month, three months, six months, one-year, two-year, three-year MCLR rates every month. The actual lending rates are ascertained after adding the spread components to the MCLR.
Repo Rate Linked Lending Rate or RLLR
Another option offered by some banks is the ‘Repo Rate Linked Home Loan’ or ‘Repo Rate Linked Lending Rate’ (RLLR). It is the rate of interest at which Reserve Bank of India lends money to commercial banks. In a Repo Rate Home Loan, the RLLR will be kept floating and will change as and when the rates from the RBI change. RLLR is made up of RBI's Repo Rate plus spread or margin.
PART PRE-PAYMENT OF HOME LOAN
The Partial Pre-payment refers to any payment made by the borrower in addition to the systematic EMIs. It shrinks the due principal amount and the interest gets calculated on the reduced principal. Pre-payment helps in decreasing the total interest paid, as the loan tenure gets shortened. The higher the prepayment amount by the borrower, the better is his or her financial management.
CHANGE IN LOAN OUTSTANDING IN RELATION TO THE EMI
The EMI that a borrower pays has a principal component, in addition to the interest. When one disburses the principal too each month, the loan outstanding lessens each month and accordingly the borrower can pay interest only on the revised and reduced value of the loan outstanding. Most banks adopt this monthly reducing basis method.
DOCUMENTS TO BE RECEIVED FROM THE BANK EVERY YEAR
All home loan lenders are required to provide the borrowers a statement at the commencement of the year that highlights how much of the total interest and principal is expected to be paid back by the borrower during that particular year. This statement can be used as a declaration of investment proof for tax deduction by the borrower. At the close of the year, the lender is expected to again share a report that includes the actual amount of interest and principal repaid so as to help the borrower avail tax benefits.
Understanding EMIs is important to make the most of a good home loan. Owning your dream house will become easier with a home loan and an EMI that perfectly suits your needs and takes into account all your financial commitments. While EMIs benefit the borrowers in planning their financial provisions every month, these scheduled and periodic instalments also help creditors by providing a constant stream of income from the loan interest.