Institutions providing home loans intermittently come
up with new forms of loans that are devised to meet the needs of house buyers
from every section of the society. However, before choosing a particular loan,
it is very important to have a comprehension about the most important constituent
of the loan - the EMIs.
An EMI, or equated monthly installment, is a certain
amount of money that is payable by you to the bank (in case you have taken a
home loan) in order to obtain legal possession of the house.
What
is an EMI?
In plain financial terms, an EMI is the amount of
money paid by borrowers, each calendar month, to the lender, for clearing their
outstanding loan. This also means that a sum of money gets deducted from your
particular account irrespective of any sudden untoward financial stringency
faced by you. EMI payments are made every month, generally on a fixed date, for
the entire tenure of the loan, till the outstanding amount has been completely
repaid.
EMI
break-up:
When it comes to segregating the sum that is payable
towards the loan, EMI is actually deduced based on an unequal combination of
principal and interest. In the initial years of the loan, a major portion of
the EMI comprises the interest payable by the borrower. As the loan matures,
and as the principal gradually gets paid, the outstanding loan amount reduces.
The interest component thus becomes lower than the principal, and finally
minimal. The EMI, though, stays as a constant amount each month, except in the
following cases:
Instances when the borrower paid a lump sum amount of
the outstanding loan, then this amount gets duly adjusted against the remaining
balance, thereby reducing the EMI. Now, in this particular case, the borrower
gets an option where he/she can maintain the EMI while reducing the loan
tenure.
In case the borrower has opted for floating rate of
interest, then the EMI varies according to market fluctuations.
The EMI of your home loan is determined by four major
factors
Principal
amount: The principal amount refers to the actual sum of
money that is borrowed by the lender. Beyond question, the principal amount is
a major determining factor towards the EMI that is to be paid by you.
Rate
of interest: The rate of interest is the rate at which
the borrower has taken money from an organization or market. This is the most
important factor when it comes to determining your EMI. The higher the rate of
interest, the greater is the EMI payable by you. It is always advisable to do a
market study of various interest rates offered by lending bodies and then
decide upon a particular product.
Loan
tenure: The tenure of the loan refers to the duration for
which the loan has been taken. The longer the duration of the loan, the lesser
the monthly EMI burden on the borrower.
Method
of computation: The method that is adopted to calculate
the EMI is a crucial factor when it comes to determining the EMI payable by
you. The various methods adopted are:
a. Annual
reducing method: In this method of EMI calculation, although the EMI is
paid by the borrower at the end of every month, the principal amount and the
rate of interest is made at the end of the year. This type of EMI calculation
has a huge disadvantage attached to it, as the borrowers continue to pay interest
on a portion of the principal that has already been paid back to the lender.
b. Monthly
reducing loans: This is a better and easy-to-understand method of EMI
calculation and is usually the most common calculation method adopted. In this
calculation methodology there is a reduction in principal with EMI being paid
every month. The interest is calculated on the outstanding balance.
c. Daily
reducing loans: As the name implies, in this method the principal reduces
every day, with daily loan repayments. The interest is charged on the
outstanding balance. However, daily EMI payment is not a very feasible option;
hence this method is not a very popular method.
Calculating
EMIs:
Mathematically, EMIs are computed using the formula
mentioned below:
EMI = (loan amount x Interest) x (1 interest) to the power of N/[(1interest) to
the power of N]-1
Interest = (% rate)/12; N = loan tenure
A typical example showing EMI calculation is as
follows:
Let's calculate the EMI for a loan of Rs 10, 00,000 @
9 per cent p.a. interest rate for 15 years.
Loan amount = Rs 10, 00,000
Monthly interest = 0.09/12 = 0.0075
N = 15 years, i.e., 180 months
EMI = (10, 00,000 x 0.0075) x (10.0075) to the power of 180/ [(1 0.0075)
to the power of 180]-1
Therefore, EMI = Rs 10,142.67
This EMI is a combination of both the interest and
principal portion of the loan, to be paid every month.
Loan
amortization schedules
A loan amortization schedule is a product that
contains home loan information such as period of scheduled payments, amount
borrowed and amount outstanding. It also gives a detailed breakup of every EMI
towards repayment of interest and the outstanding principal of the loan. The
amortization table is prepared with the use of financial mathematics by
financial institutions. It helps borrowers make vital decisions about their
loan, on prepayment or refinance. It also provides details of interest for tax
related benefits.
Step
up and step down EMI
EMIs are at times planned according to the expected
increase and decrease in the salary of the borrower.
In step up EMI, the EMI is gradually increased on the
premise that the salary of the borrower will increase in the future. In this
system, the initial EMI charged is less, and it increases as the expected
income of the borrower increases. The change in EMI would be done twice during
the entire loan tenure.
Similarly, in the case of step down EMI, the initial
EMI charged is substantially higher and it gradually reduces with the number of
payments done.
Pre-EMI
and advance disbursements
There are instances where the borrower may opt for a
partial disbursement of their home loan on the basis of the stages of
construction of their house. In such cases, a pre-EMI is to be paid every month
till the final loan is disbursed. The real loan repayment would commence only
after the entire loan is disbursed. This pre-EMI would, therefore, comprise
only the interest accrued on the disbursed money.
Also, there are cases when the entire loan may be
disbursed by lenders before the completion of house construction. This is known
as an advance disbursement and is undertaken by the lender when it is requested
by the borrower and the lender is convinced of the capabilities of the builder
to complete the construction work in time.
In these cases, the EMI payment starts immediately
from the date of disbursement.
Fixed
and floating rate of interest
EMIs can be calculated either on a fixed or a
floating rate of interest.
Fixed rate of interest: A fixed rate of interest is
charged throughout the loan tenure, thereby making the EMI payable a constant
sum. It is generally better to opt for a fixed rate only when the prevailing
interest rates have reached rock bottom levels and if an upward trend is
anticipated.
Floating rate of interest: Floating rates vary with
the market lending rates and are thus prone to fluctuations. The calculate home loan emi
would increase or decrease depending on the interest rate movement. In this
case, banks provide an alternative to increase the tenure of the loan, at a
constant EMI, for borrowers who do not desire their EMI to be increased in case
of higher interest rates.
Source: http://www.pr4-articles.com/PR4-Article-Directory/how-your-home-loan-emis-are-calculated
