The real estate market is a vast and often, confusing space to inhabit. There are several phases in it, and potential home buyers must acquaint themselves with each other step by step. Along the way, there is much jargon and several mathematical calculations to understand.
If you thought you were lucky enough to have escaped the clutches of maths in school, think again: you will need to use a calculator when you navigate the home loan process! Luckily, you can use several online tools such as loan eligibility calculators and loan EMI calculators to find out the closest approximations of the figures you seek. But yet, it is important to know how the lending institution computes your loan amount and EMI.
The EMI conundrum
Several potential home buyers balk at buying a first home because they are afraid of how much the home loan is going to cost them. Broadly, the components of the home loan are:
- Principal amount
- Interest charged by the lender
- Tenure
- EMI, paid every month till the loan is repaid in full
Of these, the last factor the EMI is what scares most home buyers. It is deducted automatically from the borrowers income every month. Come what may, you cannot skip paying the monthly instalment, or your loan will be categorised as a default. If the EMI is defaulted more than thrice, the bank may decide to terminate the loan and attach the property to recover its unpaid dues.
Normally, banks and financial institutions compute the EMI such that it does not exceed 50% of the applicants monthly income. This benchmark is an important consideration when using the EMI calculator, if you find that the projected EMI on a proposed house purchase exceeds 50% of your monthly pay check, it simply means that either your income is insufficient to buy that particular property, or you may need to select a more affordable house.
How the EMI is calculated
Instead of worrying about how much the EMI on your new home loan will cost you every month, simply start by using an EMI calculator. Remember a basic rule in EMI repayment: the higher the EMI, the less the amount of money left over for your daily expenses. Hence, you must look to reduce the EMI as much as possible. You can do this by opting for a home loan at a lower rate of interest.
The EMI is an amount of money calculated by the lender after taking the following into account: the principal amount (P), interest payable (I), and total number of instalments (N). Your bank will use this formula to calculate your EMI:
[P x I x (1 + I) x N] ÷ (1 + I) x (N-1)
Now suppose you seek a home loan of Rs 50 lakh (P) at an interest rate of 9.6% (I) for a tenure of 10 years, i.e. 120 months (N). You may use these numbers in the formula given above to find how much EMI you will pay. It is important to know this calculation even if you use the online EMI calculator, and especially if the calculations differ significantly if done manually and digitally.
What you must know about paying your EMIs:
- If you take a housing loan for an under-construction property, you will start paying EMIs even if you have not received possession of the house. During this time, you will pay the interest on the loan only, and not the principal amount.
- The EMI is not calculated to include equal parts principal amount and equal parts interest. You will pay more interest than principal amount in the initial years of the loan. Later, the interest component decreases and the principal amount increases.
- Hence, if you have crossed the half-way mark on a 20-year-old loan, you may not have repaid half the loan yet. Check with the lending institution every year about how much total amount you have repaid.
- The EMI spread and amount can be changed if you choose to periodically repay larger sums of money. For instance, if you save money every month to repay a larger chunk every six months, the overall repayment amount is reduced. At this point, you can have the monthly EMI adjusted.
- You can also change the EMI structure if you opt for a floating rate of interest, or if you pay differential EMIs, i.e. lower amounts for a few years and then larger EMIs later. This option is offered only by a few financial institutions in India.
Choosing the right bank to partner with you on your home purchase is crucial. Often, the lowest interest rate does not translate into the best home loan product. The most reputed banking institutions take the time to check your eligibility, offer you a pre-approved loan and also do a thorough check on your finances and property documents.