Rest Clause In Home Loans: How This May Increase Or Decrease Your Interest Payout
One of the many terms that seem gobbledygook to most buyers as soon as they enter the world of home finance is ‘rest’, a period representing the interval at which the bank recalculates the balance loan amount during the repayment process. If you have applied for a floating rate of interest on your home loan, you must have a clear understanding of the term ‘rest’, since that is going to determine how much you end up repaying your bank. Those who have taken a fixed-rate home loan, on the other hand, need not bother, as ‘rest’ does not come into play in their case. Now how does the rest that your bank applies affect your payout to the bank? Let us understand the term and how it works in a home-loan repayment process.
...all the rest of it!
As a borrower, when you pay your EMIs (equated monthly instalments), your outstanding loan should also reduce every month. But it is not always so. The frequency of reduction in your loan balance depends on the ‘rest’ as stated in your loan agreement. You may be paying your instalments on a monthly basis, but the definite period after which your bank recalculates the reduction in the principal amount may not be the same — lenders can have a daily, monthly, quarterly or annual rest.
If, say, your bank has an annual rest, your outstanding loan liability reflects a decrease only after a year despite you paying instalments every month. In case of a quarterly rest, the repaid principal amount is calculated and reflected after three months. But, on the other hand, if your home loan agreement specifies that it has a monthly rest, the principal amount is reduced with each EMI that you pay — that significantly lowers your interest payout over the long term. Similarly, your savings on interest outgo would be even more if your home loan agreement has a daily rest clause.
Let us see how that works.
If you have taken a home loan of Rs 50 lakh at an annual rate of 8.5 per cent for a period of 20 years, with a monthly rest, the total amount that you pay over the full tenure is Rs 10,413,879. Of this, your total interest payout is Rs 54,13,879. Now compare that with quarterly rest. For the same borrowed amount for the same tenure at the same rate, you pay Rs 10,457,060, of which interest is Rs 5,457,060 — Rs 43,181 more. Likewise, if you look at an annual rest, the total payout over 20 years comes to Rs 1,05,67,097. Of this, interest is Rs 55,67,097.
However, if you take into account a daily rest, the total payout is Rs 1,04,00,349, and of that the interest amount is Rs 54,00,348 — Rs 1,66,749 less than in annual rest. This implies, as a borrower you pay a lower amount with higher rest frequency, and vice versa.
No prizes for guessing, then, that it is in your best interest to opt for a home loan product that offers a daily or monthly rest clause than one with quarterly or annual rest.
Which rest clause should you go for?
Typically, banks offer home loans on a monthly-rest basis. However, there are some home loan products available in the market, such as SBI Max Gain, IDBI Home Loan Interest Saver and HSBC Smart Home, where interest is calculated on daily reducing balance.
Home loan products that work on the daily reduction method are specifically designed for customers who plan to repay their loans faster and are individuals involved in capital-intensive ventures. This means apart from your monthly EMI, you will have to make regular payments to keep this arrangement working to your advantage.
This works the other way around, too.
Since the interest is calculated daily, normally on the first date of a month, you will also be liable to pay higher interest in case you miss an EMI. Opting for the daily rest clause would make sense only if you are certain of prepaying your loan. If that does not look like a definite possibility, monthly rest would work the best for you. Also, a constant tracking of the process is required to make the most of the opportunity a daily rest provides.
Also be mindful of the fact that all pre-payments made towards your home loan using this facility are not really treated as ‘pre-payment’ under the Income-Tax Act. You can claim a tax benefit only if the part ‘prepayment’ amount is equivalent to interest deduction under Section 80 (C) (Rs 1.5 lakh in case of second property) or Section 24 (Rs 2 lakh in case of self-owned property). This means no rebates would be available to you for making this payment.
In the light of these facts, for salaried individuals who have only a stable monthly income to depend on, it makes more sense to go for monthly rest.