Home loan interest: All you need to know about it

Real estate concept

It is the most important component of the home loan, but very few actually understand its significance. Here’s a primer on how to make the interest work to your advantage.

Of all the terms associated with home loan finance, the ‘interest’ is the most important one. But for a new home loan borrower, the ramifications of the interest may not be immediately apparent. It plays a big role in the overall repayment schedule and it can impact your finances in a major way.

Here’s a guide on understanding what home loan interest means to your loan and to your finances:

#1 Fixed v/s floating rate of interest.

The first choice you will have to make as a potential borrower, is to choose between fixed and floating rate of interest. This is what both of them mean:

Fixed rate of interest: The interest remains the same throughout the tenure of the home loan. It is normally higher amongst the home loan rates today in the country. If it is, say, 9% at the start of the home loan, it will be 9% when you eventually close the loan. The EMI remains constant throughout the loan tenure. Fixed interest rates are good for those who wish to have the same amount of money repaid to the lender every month, without changes.

Floating rate of interest: The interest rate changes as per market fluctuations. For instance, if you have taken a home loan at 8.65% and the rates have now adjusted to 8.5%, the lending institution will adjust to a lower interest. Thus, it is amenable to change every time the market rates fluctuate. While it is always better to have a reduced rate of interest so that your EMIs are reduced, you can also be subjected to higher EMIs if the rates increase in the future.[1]

#2 EMI < 50% of monthly income.

The interest rate is important because it determines two elements: Your monthly EMI amount, and the overall money you end up repaying the lending institution. The higher the interest rate, the more the EMI you pay every month. It is advised that your EMI should not exceed 50% of the monthly income you make[2]. Any higher, and you end up stretching your expenses. Remember, the EMI is a compulsory expense – you might have to compromise on household expenditure if the EMI is too high. So when you research home loan rates today, do find a housing finance company that is offering home loan finance with interest at the lower end of the spectrum. Banks like SBI are offering floating rate of interest at 8.5% per annum, as are reputed financial institutions like Punjab National Bank Housing Finance Limited (PNBHFL).

#3 Fixed interest slabs for a few years.

Reputed housing finance agencies are also offering interesting options on loan interest to help customers save money and streamline the EMI process. For instance, PNBHFL offers fixed rate of interest for 2, 3, 5 and 10 years. The interest rates are different for salaried, self-employed professionals, and self-employed non-professionals. Once the fixed rate period is over, PNBHFL switches the customer over to a floating rate of interest for the remainder of the loan. This is a helpful feature for those who prefer a fixed rate of interest in the initial years of the loan, and who look to consolidate and save money in the later years[3].

#4 A loan transfer saves money.

After researching the different home loan finance products in the country, you finally select the most suitable one for yourself. A few days later, your loan application is approved, the loan money is disbursed and you buy your dream home. The EMI cycle commences, where you pay a mix of interest and principal payment till the end of the loan. However, you may later discover that another lending institution offers a lower rate of interest. You are not obliged to continue paying a higher rate of interest for a comparable home loan product. Either your existing loan provider must renegotiate the interest terms, or allow you to transfer your balance loan to another lender for a lower rate of interest[4]. However, you must pay loan transfer and processing fees while doing so.

#5 There is also another interest type to think about.

We’re talking about ‘pre-EMI’ or the interest that you pay before the EMI payment cycle commences[5]. You pay pre-EMI under two conditions:

1) Suppose you have taken home loan finance to move into a ready possession home. At the time of taking the loan disbursal cheque, the lending institution asks you which date you would prefer the EMI to be debited from your account. Normally, you can choose the 5th, 10th or 15th of every month to be your EMI payment date. If you choose, say, the 5th of every month to pay the EMI, and your loan disbursal cheque is given to you, say, on the 20th day of the current month, then you must pay a ‘broken interest’ from the 21st day of the current month to the 4th day of the next month. From the 5th day, your first EMI will be debited.

2) Suppose you take a home loan to invest in an under-construction property. In this case, the lending institution will disburse the money today, but the actual EMI cycle will commence from the date of possession of the house. In the meantime, you must pay pre-EMI every month. This pre-EMI is only the interest paid on the loan amount you have borrowed. It is different from the interest you pay once the EMI cycle commences.

This is, in a nutshell, how the interest on your home loan works. We hope this article has enhanced your understanding of the interest on your home loan.

[1] http://www.deal4loans.com/home-loans-interest-rates.php

[2] https://www.bankbazaar.com/home-loan-emi-calculator.html

[3] https://www.pnbhousing.com/home-loan/home-purchase-loan/interest-rates/

[4] http://www.livemint.com/Money/voW6hhp3Q11stGQ10avTLL/Is-transferring-that-home-loan-worth-it.html

[5] https://emicalculator.net/pre-emi-vs-full-emi-understanding-payment-schemes-for-under-construction-properties/