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Home loans: It's the EMI that matters

Arti Sharma

What kind of a loan do you want?
A home loan.
Do you want fixed or floating interest rates?
Whichever loan is cheaper.
Do you want interest to be calculated at annual rests or monthly?
Well, I dunno....

For those who are confused by all the jargon, here's a simple one-line rule: to find out which is the cheapest loan right now, look at the equated monthly installments of loan repayments, not the headline interest rates.

Says a personal banking officer of the State Bank of India: "Always consider the EMI, since it will give you a better idea regarding the terms. You know exactly what you will be paying."

But should one opt for loans where interest is calculated at monthly rests or annually? What are these two systems about, and how does it make a difference to repayment? Annual rest means that the principal amount outstanding, on which interest is calculated, is constant throughout the year.

The principal repayments made through the year are taken into account only at the end of the year. In the monthly rest system, the interest is calculated on a constantly decreasing principal every month. So EMIs will be lower than when calculated at annual rests.

Some players such as HDFC still offer the annual rest option, but mostly the monthly rest option is used. "If the rates are the same in the short term, the monthly rest is lower. In the long term, one is neutral about either," says Suresh Menon, general manager, operations, Mumbai region, HDFC.

ICICI Bank, on the other hand, offers only monthly rest calculations. But take a look at HDFC's figures to get a better idea. Under the monthly rest option for a 10-year loan, at a 10.25 fixed rate of interest one would end up paying Rs 1,336 as the EMI for a loan of Rs 1 lakh.

On the other hand, for the same time period, on an annual rest basis, one would have to pay Rs 1,357 as EMI per lakh. However, for a longer term period, say for 20 years, the fixed rate works out to be marginally lower under the annual rest.

Under monthly rests, the EMI per lakh at 10.75 per cent works out to Rs 1,016 whereas at annual rests the EMI per lakh, at 10.5 per cent, works out to Rs 1,013. As Menon says, in the long run it really doesn't matter, but in the short term stick to the monthly rest option.

The problem for home loan seekers is that fixed and floating rates may often not be what they seem. For example, some banks and institutions that offer floating rates do not move rates down as fast as market interest rates do. Others offer fixed rates only for a year, and then shift to floating rates.

Says Menon of HDFC: "Customers must read the fineprint regarding the two products - floating and fixed rates. They should find out if the rates are actually fixed or floating."

One downside with floating rates is the risk inherent in it. As long as interest rates are benign, floating rates are great. But what if they start rising? In that event, borrowers may find that either they may have to raise EMIs or their loan tenures will suddenly start extending.

You thought you took a five-year loan at 9.25 per cent interest. But if interest rates rose, the repayment period will stretch beyond five years. So in case of a floating rate, borrowers would do well to find out what will be adjusted EMI or tenure in case the rate changes.

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