Tuesday October 14, 06:00 PM
Learn how your EMI is calculated |
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By Personalfn.com
It is crucial to understand how housing finance companies (HFCs) charge interest to arrive at the value of EMI that you are supposed to pay. This will help you find out how the different methods of interest calculation change the value of your EMI. A little attentiveness could save you a few thousand rupees.
The way housing finance companies (HFCs) charge interest to arrive at the value EMI can be broadly classified into
- Flat Rate System
- Reducing Balance
- Rate System
In the flat rate system, the rate of interest on the loan amount is calculated over the entire duration of the loan. The principal plus the interest is divided over the number of installments and the value arrived is your EMI. In case of `Reducing Balance' system, the interest is charged on the outstanding balance of the loan, which goes on reducing.
The reducing balance can be further classified into
- Monthly Reducing
- Quarterly Reducing
- Annual Reducing
This is based on the number of times the principal is reduced/credited in a year. Suppose the principal is reduced 12 times a year, it is termed as monthly reducing balance method, if the principal is reduced 4 times a year, it termed as quarterly reducing balance method and if the principal is reduced once a year, it known as annual reducing balance method.
Annual reducing balance method is very common with Indian HFCs and monthly reducing balance method is popular among the foreign banks and nationalized banks, engaged in the activity of housing finance.
Lets find out the effect of the different methods of EMI calculation:
Unravelling the EMI
| Method of calculation |
Annual reduing (A) |
Monthly reducing (B) |
Difference (per month) |
| Loan amount: |
Rs 1,000,000 |
Rs 1,000,000 |
- |
| Interest rate |
11.25% |
11.25% |
- |
| EMI (Rs) |
11,750 |
11,523 |
227 |
| Years |
15 |
15 |
- |
This is because in the case of monthly reducing balance method you are required to pay interest on the principal, which is reduced every month.
But in case of annual reducing balance method, the principal is reduced once in a year, that too at the end of the year.
Therefore, as a borrower it is in your interest to choose an HFC that charges interest on a monthly reducing balance.
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