Home Loan: Interest calculation is crucial     (27-Dec-2001 )

Home Loan Interest rate calculation

In the previous article we discussed about the EMI (equated monthly installment) component (Principal + Interest). We discovered that in the initial years, the interest component of the annual repayment for the loan could be as high as 80% of the payment.

In this article we would like to highlight the way housing finance companies (HFCs) charge interest to arrive at the value of EMI that you are supposed to pay. This will help us find out how the different methods of interest calculation change the value of your EMI.

The way housing finance companies (HFCs) charge interest to arrive at the value EMI can be broadly classified into ‘Flat rate system' and ‘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 and the principal plus the interest is divided over the number of installments and the value arrived is your EMI. But 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 and annual reducing methods 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 time a year, it termed as quarterly reducing balance method and if the principal is reduced 1 time 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

Loan amount: Rs 1,000,000
Years: 15
Interest: 12.25% (monthly reducing)
Interest: 12.25% (annual reducing)


Method of calculation Annual reducing Monthly reducing Difference
Loan Amount (Rs) 1,000,000 1,000,000 -
Interest rate (%) 12.25 12.25 -
EMI (Rs) 12,400 12,163 237
Years 15 15 -

The table above clearly shows that EMI pay out for the same loan amount, interest and years, is much lower in case of monthly reducing balance method as compared to annual reducing balance method. 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. As a borrower you are definitely benefited going with HFCs that charge interest on a monthly reducing balance.

Another generic classification of EMI calculation and the interest rate charged, followed by HFCs and banks are, fixed or floating rate of interest. In the recent past, floating rate scheme for housing loan has become popular. Under this scheme, the rate charged varies with a benchmark, which is the generally prime lending-rate (PLR). But in case of fixed interest rate home loan scheme, the interest rate charged by HFCs remains fixed or same throughout the term of the loan. Most of the nationalized banks and foreign banks prefer to offer floating rate of interest on housing loan.

HDFC, the market leader in the domestic housing finance industry was the first HFC to offer floating rate home loan scheme in the form of Adjustable Prime Lending Rate (APLR). The most recent housing finance companies to offer floating rate housing loan scheme is ICICI home loan. ICICI home loan has stirred up competition in the housing finance industry by launching floating rate scheme at 11.5%, that too on monthly reducing balance method. The current rate offered by ICICI home loan is by far the lowest in the industry.

So, while applying for a home loan always keep in mind these classifications and make sure you inquire into the mode of interest calculation, or to make it simpler check the EMI value per Rs 100,000. Needless to say, lower the EMI, the better for you.

Share |

1  Responses to
  • Gabriel Nadar
    Updated on
    Sep 17, 2012
      the table is clear that the interest amount will be higher in flat rate, but the point is the break up of emi if in case of flat rate the principal component is higher in a emi than that's beneficial to the customer, i think banks are not thinking about consumer and awareness is required amount the consumer so that they can raise their voice against unfair practices..

  • Post Comment

    * Comments are moderated by PersonalFN, in accordance with the Terms of Use, and may not appear on this article until they have been reviewed and deemed appropriate for posting.

    Quanutm Information Services Pvt. Ltd. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of PersonalFN is strictly prohibited and shall be deemed to be copyright infringement.

    Disclaimer: Quantum Information Services Pvt. Limited (PersonalFN) is not providing any investment advice through this service and, does not constitute or is not intended to constitute an offer to buy or sell, or a solicitation to an offer to buy or sell financial products, units or securities. All content and information is provided on an 'As Is' basis by PersonalFN. Information herein is believed to be reliable but PersonalFN does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. PersonalFN and its subsidiaries / affiliates / sponsors or employees, personnel, directors will not be responsible for any direct / indirect loss or liability incurred by the user as a consequence of him or any other person on his behalf taking any investment decisions based on the contents and information provided herein. This is not a specific advisory service to meet the requirements of a specific client. Use of this information is at the user's own risk. The user must make his own investment decisions based on his specific investment objective and financial position and using such independent advisors as he believes necessary. All intellectual property rights emerging from this newsletter are and shall remain with PersonalFN. This is for your personal use and you shall not resell, copy, or redistribute this newsletter or any part of it, or use it for any commercial purpose. The performance data quoted represents past performance and does not guarantee future results. As a condition to accessing PersonalFN’s content and website, you agree to our Terms and Conditions of Use, available here.