However, in spite of two lending institutions offering us a loan at an identical rate of interest, in all likelihood the cost of our loan may greatly differ between both these lenders depending on the rate of interest and the methods used by them. Also, if one lender is offering an interest rate lower lower than the other, it need not necessarily mean that the lower interest rate loan is a cheaper option. Apart from the rate of interest we also need to know the method of calculating interest adopted by the lenders, which plays an important part in justifying the profits of the lender and the loss incurred by the loan seeker.
* EMIS (Equated Monthly Installments)
The repayment of the principal and the interest on the home loans is undertaken through EMIs i.e. Equated Monthly Installments. Besides the rate of interest, the value of the interest component of EMI largely depends on the method used by the loan lender for calculating or computing the interest.
* Reducing Balance Method
Lenders usually adopt the reducing balance method for ascertaining the interest payable on loans. Herein, the interest is levied on the principal amount outstanding on the loan at a given point of time. Since the principal amount of the loan reduces as and when repayment on the loan is undertaken , the interest amounts also lowers, since it is charged as a percentage of the reduced principal amount. The frequency of computing the interest using this reducing balance method is important. Interest can be computed on reducing balance on a monthly, quarterly, half-year; or on an annual basis.
* Monthly, Quaterly, Half -Yearly And Annual Rests
Under a monthly rest system, the monthly principal position that we pay on our EMIs gets deducted when calculating the interest rate for the subsequent month. The principal is reduced 12 times in a year and the interest is charged only for the outstanding principal amount on a monthly basis. Similarly under quarterly, half yearly and annual rest methods, the principal amount is deducted after every 3, 6 and 12 months respectively.
* Reasons why monthly reducing is more preferable than quarterly,
half-yearly and annual:
The greater the frequency of computation or calculation of interest, the lower the effective interest cost we have to bear. For instance, if we take a home loan of Rs.15 lakh for a 20 year tenure at a floating interest rate of 8 (purely an assumption made to understand the methods used) percent per annums, the EMIs applicable will be Rs.12,547, Rs.12,580, Rs.12,732 under the monthly, quarterly half yearly and annual rest methods, respectively. The difference between the EMI amount under the monthly and annual rest methods works out to be Rs.185, which translates into a significant difference of approximately Rs.44,400 over the entire 20 -year tenure of the loan. This example shows that Equated Monthly installment is the lowest when the interest is calculated by the monthly reducing method.
*Beware of the fox minded loan lenders on the prowl
Nowadays, a few lenders have been following a certain method while calculating interest on home loans, i.e. the annual reducing method which indirectly is a loss to the loan payers and a fruiting benefit for the lenders. This has forced borrowers to bear a higher repayment burden. Although lenders declare the method used in the loan agreement, these disclosures fail to make a borrower aware of the implications of the other interest calculation methods to understand which method is most suited for him.
* Monopolies and restrictive trade practices commision(MRTPC): CRACKING THE WHIP
However, this unfair trade practice has now come under the
scanner recently, with the Monopolies and Restrictive Trade
Practices commission (MRTPC) issuing an order against a leading
home lender for following the annual rest method wherein a monthly
rest is more justified. Due to lack of adequate information
and poor level of transparency involved in explaining the terms
of an annual rest the MRTPC has asked the concerned lender to
do away with the annual rest system of charging interest. If
the Supreme Court rules in favor of MRTPC, home loan consumers
* Be alert and careful before signing a deal
To avoid getting caught by your neck from the money lenders dont blindly just trust the lender. Read your home loans agreement cautiously and determine the mode of interest levied on your loan so that you save yourself from an inflated cost on it.
Keeping the above things in mind you can ready to be well protected from the various deceptive methods which you may be unknowingly falling prey for.
At the end some major points to be kept in mind while availing for any home loan scheme from any money lender by understanding the methods adopted by them for computing interest and to select the most appropriate one for you:
*The effective financing cost on your home loans depends on the interest rate and the way it is calculated.
*The reducing balance system of charging interest is often
followed by lenders. So have proper information regarding it.
* This method can be further broken down into monthly, quarterly, half -yearly and annual reducing system. Preferring monthly reducing system above quarterly, half yearly and annually would be a better aspect.
*Interest outgo is highest under the annual reducing method and lowest under the unfair trade practice of following annual rest method.
*Read your home loan agreement cautiously and determine the mode of interest levied on your loan by the money lender.
*Beware of the deceptive trade practice used by the money lender.
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