## What is a Home Loan?

A Home Loan is a loan offered by a bank or a non-banking financial institution to individuals and others for purchasing or constructing their homes. It is a secured loan, as the borrower has to mortgage the property in favour of the bank. On repaying the loan amount, the bank transfers the ownership of the property to the borrower.

## Home Loan Repayment

Since the Home Loan is secured finance, the rate of interest on Home Loans is less when compared to other loans. The repayment of the Home Loan depends on the income of the borrower and their repaying capacity. Generally, the preferred mode of repayment is the Equated Monthly Instalment (EMI) method. Some of the other techniques include repayment in quarterly, half-yearly, or yearly instalments. It depends on the frequency of the income of the borrower. Usually, Home Loans to farmers and agriculturists have such repayment periods to coincide with the harvesting periods.

## What is an EMI?

In layman terms, EMI stands for Equated Monthly Instalments. It constitutes the amount that the borrower has to repay every month for the entire tenure of the loan.

The EMI of a Home Loan depends on the following factors:

• The loan amount
• The loan repayment tenure
• The rate of interest

Of these factors, the loan amount does not change unless you go for a Home Loan Top-Up. The rate of interest can fluctuate depending on the market rates. Under such circumstances, the borrower has two options.

• Keep the EMI constant while changing the loan repayment tenure
• Keep the tenure constant and alter the EMI accordingly

Usually, banks prefer to go for the former option. Hence, an increase in the rate of interest can extend the loan repayment tenure.

## How Do You Calculate the EMI?

The EMI calculation is a mathematical procedure. The mathematical formula for calculating the EMI of a Home Loan is as follows:

• EMI = [PXRX(1+R)^N] / [(1+R)^N - 1]

P = Principal amount of the Loan

R = Rate of interest (If the rate of interest is 10%, R = 10/1200)

N = Number of monthly instalment

You can use MS Excel tables to find out the EMI using this formula.

However, it is not necessary, as readymade EMI calculators are available on almost all bank websites. MyMoneyMantra has an EMI Calculator in the Financial Tools section of the official website. Using this tool is easy.

• Access the official website of MyMoneyMantra
• Select Financial Tools option and proceed to EMI Calculator
• Enter the details such as loan amount, the loan repayment tenure, and the rate of interest. Click on the Calculate option.
• You get a detailed working of the EMI along with the amortisation schedule

## How Do Banks Calculate Interest on Home Loans?

Banks offer two types of interest rates on Home Loans:

• Floating Rates: The floating rate of interest varies with the market rates. Banks have interest rate mechanisms such as Prime Lending Rate (PLR), Base Rate (BR), and Marginal Cost of Funds Based Lending Rate (MCLR). Today, banks like State Bank of India offer Repo Rate Linked Interest Rates for Home Loans.

With effect from 01st April 2016, all banks switched over to the MCLR method. Loans sanctioned after 01st April 2016 were automatically linked to the MCLR.

The MCLR comprises of four components:

• Marginal Cost of Funds
• Operating Expenses
• Cash Reserve Ratio

Banks declare their MCLR usually at 6-month intervals. Hence, the rate of interest on the loans linked to MCLR will change every time the bank alters its MCLR.

The Repo Rate Linked Interest Rate is a full market rate-oriented mechanism, as the rate of interest changes with every change in the Repo Rate. The Reserve Bank of India announces the Repo Rates from time to time. State Bank of India has a separate Home Loan product in this category.

• Fixed Rates: As the name suggests, Fixed Rates are those rates of interest that do not change during the tenure of the Home Loan. Thus, the EMI in the case of a Fixed Rate Home Loan will not change. The loan repayment tenure will also remain fixed. This rate protects borrowers against extreme market fluctuations that can affect their Home Loan interest rates. Usually, the fixed rates are a minimum of 1.5% more than the floating rates. Thus, the borrower has to pay a higher EMI. However, the benefit is that the rates remain fixed even if the floating rates increase.

In the past, banks used to offer fixed rates for the entire tenure of the loan. Nowadays, the banks stipulate a reset option where they change the fixed rate after a specific period, usually five years. The customer also has the opportunity to switch over from the fixed rate to the floating rate and vice versa, subject to the payment of conversion fees.

## The Rate of Interest Calculation Method

Banks calculate interest on daily reducing balances. Thus, your outstanding loan balance keeps on reducing as you pay your instalments on time. The EMI comprises of two components, the principal component and the interest component. In the initial stages, the interest component is high. It reduces every month as the repayment is made into the account. Banks charge interest on compounding basis. Hence, you have to pay interest on the interest component, as well. This amortisation table can help you understand the concept better.

Here are some assumptions:

• Loan amount: 10 Lakhs
• Repayment tenure: 15 years
• Rate of interest: 9%

EMI works out to be 10,143 per month

 Year Opening Balance EMI X 12 Yearly Interest Principal repaid yearly Closing Balance 1 10,00,000 1,21,712 88,659 33,053 9,66,947 2 9,66,947 1,21,712 85,558 36,154 9,30,793 3 9,30,793 1,21,712 82,166 39,545 8,91,247 4 8,91,247 1,21,712 78,457 43,255 8,47,992 5 8,47,992 1,21,712 74,399 47,313 8,00679 6 8,00679 1,21,712 69,961 51,751 7,48,928 7 7,48,928 1,21,712 65,106 56,606 6,92,323 8 6,92,323 1,21,712 59,896 61,916 6,30,407 9 6,30,407 1,21,712 53,988 67,724 5,62,683 10 5,62,683 1,21,712 47,635 74,077 4,88,606 11 4,88,606 1,21,712 40,686 81,026 4,07,581 12 4,07,581 1,21,712 33,086 88,626 3,18,954 13 3,18,954 1,21,712 24,772 96,940 2,22,014 14 2,22,014 1,21,712 15,678 1,06,034 1,15,981 15 1,15,981 1,21,712 5,731 1,15,980 NIL

*Source - HDFC Amortisation Schedule

Every bank in India charges interest on Home Loans in the manner described above. The rates can be different because they depend on the MCLR or Bank Rate of the particular bank. However, the mode of calculation of Home Loan interest is similar.

### Do I have the option to switch over from the Bank Rate to the MCLR-based rates?

Yes, banks give you the option to switch from the Bank Rate-linked ROI to the MCLR-linked ROI. The vice versa is not possible.

### Which is advantageous, the fixed-rate or the floating rate?

Nowadays, the banks do not offer fixed rates for the entire tenure of the loan. They include a reset option in the sanction terms. Secondly, the Home Loan is a priority in the Indian financial sector. The rate of interest on the Home Loan will always be lower as compared to other loans. The chances of the floating rate of interest exceeding the fixed rate are negligible. Under such circumstances, it is a better option to opt for the floating rate of interest as compared to the fixed rates.

### In the case of an interest rate variation, is it advisable to change the EMI and keep the tenure constant?

Yes, it is beneficial to keep the tenure constant and increase the EMI. However, banks prefer to increase the tenure, as it is convenient for them. Changing the EMI entails altering the ECS demands or replacement of Post-dated Cheques. From the customer's angle, it is better to increase the EMI and keep the tenure the same.

### How much will the EMI increase if there is an increase in the Home Loan rates by 0.50%?

For a loan of 10 Lakhs @9%, the EMI is 10,143 for 15 years. If the rate of interest increases to 9.50%, the EMI becomes 10,442 (an increase of 299). If you prefer to keep your EMI constant, the tenure increases by approximately one year.

### What is the Repo Rate Linked Interest Rate concept?

The Repo Rate Linked Interest rate concept is the best market-rate driven interest concept in the country today. The Reserve Bank of India announces changes in the Repo Rate at stipulated intervals. The banks load the spread over the repo rate announced by RBI. The Repo Rate depends on the current market demand and supply position. Accordingly, the rate of interest on Home Loans changes, as well. Hence, the repo-rate linked interest rate concept is the ideal one.

### How do the banks calculate interest on PMAY accounts?

PMAY Home Loan borrowers get upfront interest subsidy. The subsidy is credited to the Home Loan account immediately on its receipt. It thus reduces the EMI burden on the borrower. The method of calculating the interest is the same, i.e., on a daily reducing balance method.

### Is there any Home Loan product that calculates interest on a simple interest basis?

In the retail segment, no Home Loan product is available that calculates interest on simple interest basis. However, there is a simple interest housing loan product in the agricultural sector. Farmers and agriculturists have annual or half-yearly income depending on the harvesting period. Home Loans to farmers that qualify as agricultural loans are available on a simple interest basis.

### How does the bank fix the instalments in the case of such Home Loans to farmers?

The banks decide on the frequency of the instalment. They divide the loan amount by the number of instalments and arrive at the principal repayment amount. Apart from the principal repayment, the farmers have to pay the interest charged for the period separately. Hence, there is no EMI concept here.

### Is it better to opt for a 15-year Home Loan or a 20-year Home Loan?

It depends on your repaying capacity. The banks calculate your eligibility by accounting for your income and repaying capability. If you can repay a higher EMI, it is better to opt for a 15-year Home Loan, as compared to a 20-year one. This calculation will help you in understanding the concept better.

• On a Home Loan of 10 lakhs @9%, the total amount payable over 15 years comes to 18,25,678. (EMI = 10,143)
• On the same loan, the EMI reduces to 8,997 for 20 years. However, you end up paying 21,59,341 over 20 years.

### Do women borrowers get a concession in the rate of interest?

Yes, some banks like the State Bank of India offer concession of 0.50% on Home Loans to women. However, the woman should be the principal borrower, and the property should be in her name to get the benefit.

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