December 2016 | Back to all Real Estate Articles
Here's how EMIs work in different situations through the tenure of a loan.
A home loan repayment is made through equated monthly instalments (EMIs). The EMIs are a part of a borrower's monthly cash flows. The EMI is the monthly amount payment made towards the repayment of a home loan, along with the interest on it. As the loan amount gets repaid, the interest amount also decreases. As it will be very difficult to calculate each month's outstanding and interest, repayments are made by EMIs.
An EMI payment includes contribution towards both the principal and interest on the loan amount. The interest component constitutes a major portion of the EMI payment in the initial stages. Over the tenure of the loan, the portion of interest reduces and contribution towards the principal increases.
It is to be noted that EMIs are directly proportional to the loan amount and interest rate, and are inversely proportional to the tenure of the loan. The higher the loan amount or interest rate, the higher is the EMI and vice versa. In case the tenure of loan increases, the amount of total interest to be paid increases too, but the EMIs decrease.
The EMI depends on the loan amount, the interest rate and the tenure of the loan. For example, the EMI for a principal amount of Rs 1 lakh, at 9.20 percent interest rate and 240 months tenure will be Rs 913. In case the interest rate is reduced to nine percent, the EMI will be Rs 900. In case the loan tenure is reduced to 120 months and interest rate remains 9.20 percent, the EMI will be Rs 1,278.
The higher the loan amount, the higher will be the EMI. Similarly, the higher the interest rate, the higher will be the EMI. Further, the shorter the loan tenure, the higher will be the EMI. The EMI will be lower in case of a lower loan amount, a lower interest rate or longer tenure. In case you increase the tenure of the loan, the EMI will come down, although the total amount of interest payable over the loan tenure will increase.
In case of a fixed rate loan, the EMI remains the same as the interest rate remains constant during the tenure. However, in case of a floating rate loan, the interest rate varies based on the prevailing market rates. Now the interest rates are based on the banks' marginal cost of lending. As this cost reduces, the interest rate goes down, thereby reducing the EMI and vice versa.
In case you make a part prepayment on the loan, it is adjusted against the principal amount outstanding, thereby resulting in a reduction in the total interest that is to be paid. This will lower the EMI.
As the interest rate goes down, the EMI also gets reduced. So, for a Rs 20 lakhs loan taken at 9.50 percent for 10 years, the EMI will be Rs 25,880. In case the repo rate is cut by 0.50 percent and the interest rate is also reduced by the bank to nine percent, the EMI will be reduced by Rs 545 to Rs 25,335.
You can make a part prepayment against the principal to reduce the EMI. Alternatively, you can opt to keep the EMIs the same. This will lead to earlier repayment of the loan and the loan tenure will be reduced as a result. In case the EMIs are kept low initially, the tenure will have to be stretched. This will increase the interest cost.
In case of a floating interest rate loan, you can take advantage of a reduction in the interest rate. In case the cost of funds for the bank decreases, the EMIs will come down too. However, you can still keep the EMIs the same, and by virtue of a reduction in the interest rate, the tenure of the loan will be reduced. Also, by continuing to pay the same EMI, you may have the option of drawing an additional amount, keeping the loan tenure unchanged.
Similarly, if the interest rate increases, the EMIs may still remain the same, and the tenure will be increased. Or alternatively, the EMI may increase, keeping the tenure unchanged.