All You Need To Know About Home Loan Interest Rate And Principal
All home loan buyers target the lowest possible equated monthly installments (EMIs) while shopping for a home loan. But there is something you should not forget. The EMI has two components: Interest and the principal.
Tax benefits on home loans are also treated separately for these two components. This is why it is important to understand the structure of EMIs so that you can repay your home loans comfortably.
MakaaniQ tells you more about the interest and principal components of home loans.
Understanding the structure of home loan EMIs
When you take a home loan, you are committing yourself to paying monthly instalments every month towards home loan repayment, be it immediately after the home loan is disbursed or after the moratorium period (i.e. the phase in the home loan term in which the home loan borrower is not required to make EMI payments). When you pay EMIs, some part of it goes toward interest and the rest goes towards principal repayment.
As you pay the EMI every month, the home loan amount keeps declining, and you will be liable to pay lesser interest on your next EMI. Now you must be wondering why your EMI remains unchanged if you pay lesser interest on your next EMI after making timely payments.
This is because the EMI is generally fixed, and this is always internally adjusted between interest and principal repayments. With each passing month, your loan is paid by some amount. The outstanding home loan amount keeps declining, and this results in lower interest payments as months and years pass by, until you finally close your loan.
Many home loan borrowers are unaware of the fact that during the initial years of home loan repayment, the interest component is very high, relative to the principal component. This is because you have just started paying EMIs. The outstanding home loan amount is still very high. Also, longer the home loan tenure, higher will be the interest component relative to the principal payments. The rate at which interest portion will come down will also be lower, ensuring that the major part of interest goes towards the home loan EMIs and that much of the principal is paid later.
You can also understand this concept of interest and principal repayment by using the EMI calculator and analysing the loan amortisation schedule.
The tax benefit on principal component is allowed under Section 80C, and the benefit of interest component is allowed under Section 24. For tax planning purposes, you must find out the cumulative interest and principal repayment over a fixed period of time.
How does pre-payment of home loan affect the EMI components?
Regardless of the type of debt, you must make efforts to come out of it as soon as you can. Whenever you have access to more funds, you should use it to clear your home loan as soon as possible.
The interest component is your immediate cost of credit. The biggest benefit of prepayment is that your interest payout reduces, and payment towards the principal component starts in major portions. You get to repay your home loan faster. Also, less interest is being accrued on the home loan account (as some portion is repaid through prepayment).
You can either keep your home loan tenure the same or shorten it after pre-payment. It is better to keep the number of EMIs as it is or home loan tenure the same to improve monthly cash flows by a lower monthly cash out flow.