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All You Need to Know About the Monthly Reducing Balance Method for Calculating Interest on Home Loans!
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Whatever you call them — home loan, housing loan, or residential loans – they help you buy your dream house without impacting your savings. However, interest rates are a crucial factor that determine your home loan monthly outflow. But have you ever wondered how the interest rates are calculated? Calculating monthly repayment is not as complex as it seems. While there are many home loan calculators available online, you must know how they function. One of the ways to calculate interest rates is the Monthly Reducing Balance (MRB) method. Read on to understand it in detail.
What is the monthly reducing balance method?
Whenever you avail a home loan, your lender allows you to repay through Equated Monthly Installments (EMI), which is a fixed amount. However, the EMI amount includes principal amount and interest component.
The monthly reducing balance method is used to calculate the interest on your outstanding balance loan amount every month. It takes into consideration your outstanding loan amount after paying EMIs every month to calculate the interest component of the next EMI.
How is interest calculated using this method?
When you pay your EMI each month, a portion of it goes towards paying the principal and interest component of the remaining loan. The interest component keeps reducing as long as you continue paying EMIs as per schedule. Hence, it is called a reducing balance method of calculating interest on loans.
Let us understand this with an example.
Example of MRB method
Assume that your loan amount is Rs. 30 lakhs, and the interest rate is 9.5% per annum for a tenure of 15 years (180 months). The EMI for this housing loan will be Rs. 31,327.
In the first month, interest is charged on Rs. 30 lakhs. From the mentioned EMI, the interest component would be Rs. 23,750 and Rs. 7,577 goes towards repaying the principal. Thus, at the end of the first month, the remaining balance would be Rs 29,92,423.
Similarly, in the consecutive month, the interest will be charged on the balance amount of Rs. 29,92,423 and not on the loan amount.
Again 9.5% interest is charged on the revised principal of Rs. 29,92,423. Thus, the interest component in the EMI would also reduce to Rs. 23,690, and the remaining amount of Rs. 7,636 goes towards the principal amount. This would continue till the entire loan amount is fully paid by the end of the tenure.
In a nutshell
The monthly reducing balance method is an excellent way to calculate interest on home loans. Ensure that you get all the information about your home loan before applying. The best home loan for you will depend on your financial situation and your future goals.
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