Purchasing your dream home is a thrilling milestone, but knowing how your monthly payments are calculated can sometimes be puzzling. Have you ever wondered how banks calculate your EMI amounts or how much interest you’ll ultimately pay? This easy-to-understand guide will simplify it for you.
What Goes into Your EMI Calculation?
Your Equated Monthly Instalment (EMI) includes both interest and principal repayment in fixed monthly instalments. Three primary factors decide your EMI amount:
● The amount you borrow is the first factor. Of course, the more you take, the higher the monthly instalment will be. Most potential homeowners calculate the monthly cost of different loan amounts using a house loan EMI calculator before applying.
● The loan tenure (repayment period) will significantly impact your EMI. The longer tenure will lower your monthly payment amount but increase your total interest over the life of the loan. Most calculations of home loan interest indicate that increasing your tenure by even a few years can significantly increase your total repayment by lakhs.
● The interest rate is the third important element. A mere 0.5% difference in your home loan interest rate can make a significant difference to your total repayment amount over a 15-20 year tenure.
Mathematical Formula Behind EMIs
Banks have a standard formula to compute your home loan EMIs:
EMI = P × r × (1 + r)^n / [(1 + r)^n – 1]
Where:
P is the principal loan amount
r is the rate of interest per month (the annual rate divided by 12 months)
n is the number of monthly payments
This long and complicated formula is automatically applied if you use a house loan EMI calculator, which saves you from the calculations.
Understanding the Amortization Schedule
When you begin paying off your loan, a larger portion of your initial EMIs is used to pay interest rather than principal. This eventually reverses over time, with subsequent EMIs having a higher principal repayment.
For instance, in a 20-year loan, your EMIs in the first year may have 80-85% interest and just 15-20% repayment of the principal. In the final few years, this proportion flips. This is evident if you employ an exhaustive house loan EMI calculator that displays your entire amortisation schedule.
How Banks Calculate the Home Loan Interest Rate
Your home loan interest rate is based on several factors:
● Credit Score: If your score is high, you are likely to receive better interest rates, as banks will perceive you as less risky. Even saving 1% on your home loan interest would save you lakhs in the course of the loan period.
● Loan-to-value ratio (LTV): This is the portion of the property value the bank will finance. A lower LTV (i.e., a larger down payment) typically results in more favourable interest rates.
Your occupation type and the stability of your income also affect the rate. Government workers and professionals with stable incomes may receive preferential interest rates compared to self-employed persons. Using a home loan EMI calculator can help you understand your monthly payments.
Fixed vs. Floating Interest Rates
Banks provide two basic interest rate options:
● Fixed rates remain constant throughout the entire loan period, providing certainty in your EMI payments. Fixed rates are generally higher upfront but save you from future rate hikes.
● Floating rates vary according to market conditions. They typically begin lower than fixed rates but can go up or down over time. The majority of home loan interest options in India today are floating rates tied to external benchmarks, such as the repo rate.
Making Informed Home Loan Decisions
Understanding how your EMIs and interest are calculated enables you to make more informed financial decisions. Using a house loan EMI calculator before finalising your loan helps you avoid future financial strain and plan your home purchase more effectively.
Keep in mind that the ideal home loan is not always the one with the lowest EMI but rather the one that offers affordable monthly installments coupled with moderate overall interest expenses during the loan period.
