### 20 SEPTEMBER, 2022

The interest rate on housing loan is a cost borne by the applicant every year for the money borrowed from the lending institution. The interest rate is calculated on the outstanding loan amount and is represented as a percentage.

A lending institution provides the applicant with their interest rate on housing loan in the form of a loan estimate document. The loan estimate is also inclusive of the Annual percentage rate (APR), which is a broader measure of all the costs associated with the loan. The Annual percentage rate includes:

• The interest rate being charged.
• Attestation charges.
• Processing fee.
• Any other specific costs related to the processing of the housing loan.

The loan applicants usually look to source this information from their shortlisted list of lending institutions. This data compares the cost and other terms and conditions to finalize the lending institution that best suits their needs and future repayment capability.

An illustration of the interest on housing loan

There are various home loan calculators available online for the ease of the customers. However, it is essential to understand what goes behind these calculations and how the lending institutions use the interest rates to calculate the equated monthly installments (EMI) for their borrowers. The applicants should be aware of these calculations before they apply for home loan.

The formula for calculating the EMI is

P x R x (1+R)^n / (1+R)^n-1

Where:

• P denotes the principal loan
• N represents the loan repayment tenure in months
• R stands for the monthly interest rate
• Monthly interest rate = annual interest rate divided by 12

The above formula can be better understood using the example below:

An applicant seeks a housing loan of Rs. 15,00,000 (P)

The tenure to repay this loan amount is 5 years / 60 months (N)

The rate of interest charged by the lending institution is 7% per annum

The monthly rate of interest is 7% divided by 12, which is equal to 0.0058% (R)

The equated monthly installments (EMI) can be calculated by incorporating these values into the above formula:

= 15,00,000 x 0.0058 x (1+0.0058)^60 / (1+0.0058)^60-1

= 29,702

Thus, the applicant, in this case, would pay a monthly EMI of Rs.29,702 for 60 months.

The total amount repaid would be Rs.29,702 x 60 = Rs.17,82,108

This implies that the borrower would incur a cost of Rs.2,82,108 on this loan. The cost incurred is the additional amount paid in excess of the principal amount that was borrowed i.e. 17,82,108 - 15,00,000 = 2,82,108.

Types of interest rates:

The lending institutions may charge either a fixed or a floating rate of interest on the housing loan offered. Let us understand both these types of interest rates and how these vary from each other.

The floating interest rate can change in the future based on various economic factors. The Reserve Bank of India determines the base rate, which is a simplified metric that captures all economic aspects and impacts the floating interest rate. The floating rate of interest is subject to change each quarter. It can rise or fall below the current rate of interest depending upon the prevailing economic condition and the decisions taken by the Reserve Bank of India. A floating interest rate is volatile, and the borrower should be aware of the associated risks before accepting it.

On the other hand, a fixed rate of interest remains the same throughout the duration of the loan. The EMIs are calculated using the same interest rate percentage for the entire repayment schedule.

The applicant should understand the EMI calculations associated with these interest rates and choose wisely. For example, a floating interest rate can be low to start with but stands a risk of rising high depending upon the future economic conditions of the economy. On the flip side, the floating interest rate can also go down in the future and provide certain monetary savings to the borrowers. One must choose a floating rate when they foresee the interest rates going down. A fixed interest rate is a wise option for borrowers who are not willing to take any risks associated with the changing interest rates.

Interest on a housing loan will not always be the only cost incurred by the borrower. The applicants should also be wary of other charges associated with the loan that may differ from one lending institution to the other. Complete disclosure of all additional costs and the rate of interest should be procured and analyzed before zeroing upon a lender.

To summarize, the interest rate on housing loans can have a more significant impact on the repayments since the tenure of the loan is usually more than 10 to 15 years. One must thoroughly understand how the EMIs are derived and the additional amount paid as interest during the repayment schedule. A single-digit interest rate number, prima-facie, may appear to be small but can cumulatively run into massive amounts depending upon the tenure of the loan.

While a home loan is always a good option, one must understand all the costs associated with the borrowing. Once understood, the applicant can decide on a balance between self-funding (initial down-payment made towards the property) and the loan amount to be taken. A proper balance between these aspects can reduce the overall costs for the borrower.

Tenure of the loan:

The cost of a housing loan, borne by the borrower, is directly proportional to the repayment tenure chosen by the borrower i.e. a shorter repayment tenure would lower the cost, and a longer repayment tenure would result in higher costs. The cost of the loan is decided by the rate of interest being levied by the lending institution.

On the other hand, the amount of equated monthly installment (EMI) is inversely proportional to the repayment tenure i.e. a longer tenure would comparatively have a lower amount of EMI and a shorter tenure would call for a higher EMI.

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