Home Loan Interest Rate: Owning a home is a significant aspiration for many Indians. It provides a sense of security, stability, and pride, which drives many individuals to take home loans to achieve this goal. Home loans often have longer tenures, making them suitable for long-term financial planning. Borrowers spread their repayments over several years, making it easier to manage their finances. At the same time, repayment involves interest payment to your lender, which makes a substantial part of your loan journey.
How is the home loan interest rate calculated?
Home loan interest rates are typically calculated using the reducing balance method, also known as the reducing balance interest calculation method. This method is commonly used by banks and financial institutions in India to determine the interest payable on a home loan.
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It’s important to note that in the reducing balance method, the interest is calculated on the outstanding principal balance. So, as you continue to make payments, the interest portion decreases, and the principal portion increases, helping you pay off your loan faster as the tenure progresses.
Principal Component: This is the portion of the EMI that goes towards repaying the principal amount. With each EMI payment, the outstanding principal decreases.
Interest Component: This is the portion of the EMI that goes towards paying the interest on the remaining outstanding principal. As you continue to make EMI payments, the interest component decreases over time.
Here’s how it works:
The interest on home loans is usually calculated either on monthly reducing or yearly reducing or daily reducing balance by the bank. For example, country’s largest lender State Bank of India charges interest on daily reducing balance.
Specifics are mentioned below: –
Annual reducing method: In this system, the principal, for which you pay interest, reduces at the end of the year. Thus, you continue to pay interest on a certain portion of the principal that you have actually paid back to the lender. This means that the EMI for the monthly reducing system is effectively less than the annual reducing system.
Monthly reducing method: In this system, the principal, for which you pay interest, reduces every month as you pay your EMI.
Daily Reducing method: In this system, the principal, for which you pay interest, reduces from the day you pay your EMI. EMI in the daily reducing system is less than in the monthly reducing system and a year is treated as consisting of 365 days irrespective of leap or non-leap year.
Home loan interest rates may be fixed or floating. Fixed rates remain constant throughout the loan tenure, while floating rates can change periodically based on market conditions. The method for calculating interest remains the same, but the interest rate itself may vary for floating rate loans.