Fixed vs. Reducing Balance Loan EMIs in 2022

Home loans in India have become very affordable today thanks to the growth of both public and private sector banks, non-banking financial institutions (NBFIs), cooperative banks, and other financial institutions.

According to the website www.livemint.com, the strong monsoon of 2022 has given a strong push to the demand for home loans in 2022, especially in Tier 2 and Tier 3 cities. A news report on business television also stated that home loans in 2022 rose to over Rs. 18 thousand crores, a 16% growth over the previous year.

It is thus clear that post-pandemic, the appetite for home loans shown by Indian consumers in 2022 is growing at a fast rate.

Types of home loans in India

There are two types of home loans that you can apply for:

1. Fixed balance loans
2. Reducing balance loans

In this blog, we will show you how to get the maximum benefit out of your home loan by deciding on the type of repayment structure (called “Equated Monthly Instalments – EMIs“) that you should choose.

Equated Monthly Instalments (EMIs)

You have purchased your dream home by taking a home loan, which you need to repay with interest. You have to pay back a fixed amount every month for the duration of the loan period, which is calculated in “number of years.” This monthly repayment is called an “Equated Monthly Instalment” or EMI.

Types of EMIs

When you select your loan, you are presented with two repayment options:

1. A fixed interest rate EMI
2. A reducing interest rate EMI

You should know the difference between these two types of EMIs to make the best decision for your home loan requirements.

What is a Fixed Interest Rate EMI?

In a fixed interest rate EMI, the rate of interest is the same for the entire loan period (called the “tenure”). The interest for the entire tenure is calculated at the start of the loan period.

What is a Reducing Interest Rate EMI?

In an EMI with a reducing interest rate, the interest amount is variable, depending on the principal amount that is outstanding based on the current interest rate.

How do you calculate your EMI under both options?

You can determine the EMIs payable under both options by using the following formulas:

1. Fixed Interest Rate EMI
   • Interest to be paid = (Loan principal amount x total duration in years of the loan x interest rate per annum) / total instalments
   • Let us assume that you have taken a loan of Rs. 1,00,000 for one year at a 12% rate of interest
   • Under the Fixed Interest Rate EMI method, the interest is calculated on the principal amount.
   • The interest amount – Rs. 12,000 – is added to the principal amount, giving a total loan value of Rs 1,12,000.
   • This amount is divided by the total number of instalments
   • Thus, the EMI payable is Rs 1,12,000 / 12 = Rs 9,333.33
2. Reducing Interest Rate EMI
   • Interest to be paid on each instalment = The remaining loan amount x the interest rate that is applicable for each instalment
   • In our example, under the Reducing Interest Rate EMI, the interest is calculated on the total amount outstanding at the beginning of each month.
   • As the total amount decreases, the EMI also decreases accordingly.
   • In this example, the total interest amount is Rs. 6,619, and you need to repay a total of Rs. 1,06,619 after 12 months.
   • Therefore, your EMI will be Rs. 1,06,619 / 12 = Rs. 8,885.

As you can see, the EMI and total loan repayment are lower under the Reducing Interest Rate method.

What factors affect EMI calculations?

According to the Economic Times, the EMI on your home loan depends on the following three factors:

1. The loan amount: the total amount that you have borrowed
2. The interest rate: the rate at which interest is charged on the amount that you have borrowed
3. The duration of the loan: the time frame in which you have to repay the entire loan (principal + interest). This is mutually agreed upon between you as the borrower and the lender

Pros and Cons of Fixed vs. Reducing Balance Loans in 2022

Here are the important pros and cons of both EMI types that you should keep in mind when deciding which will work better for your home loan repayment:

1. Fixed Interest Rate loans
   • The biggest advantage is that the monthly amount to be paid does not change throughout the loan period. This helps you better plan your monthly budget
   • The interest rate is also fixed and does not fluctuate up or down with changes in interest rates announced by your bank
   • However, the same benefit of a fixed interest rate can also be a disadvantage because you could pay a higher rate of interest even if your bank reduces its interest rate.
   • While the interest rate could be lower in Fixed Interest Rate loans, the EMI amount that you pay will also be higher.
2. Reducing Balance Rate loans
   • Under this method, you pay a lower interest rate over time because it is calculated on the principal amount that has to be repaid.
   • Thus, the interest on your loan will gradually reduce.
   • However, the interest rate in this method is more complicated
   • The EMI amount that you pay is also not a fixed amount for the entire loan duration, and this could lead to complications in your annual budgeting or financial planning.

Conclusion

Home loans are a necessary and convenient way of financing your house purchase. Regular instalments, known as Equated Monthly Instalments, or EMIs, are the way in which you pay back your loan, over a fixed period of time.

However, you must decide on the best method of EMI payment—whether Fixed Interest Rate EMIs or Reducing Balance Rate EMIs. This decision should be made as per your home loan requirements, and you must always consult your financial advisor to make an informed decision.

Visit https://www.piramalfinance.com/ to learn more about how to choose the best EMI method to repay your home loan easily and conveniently, without breaking your savings or finances.