Question from a reader:
My housing loan is being disbursed in stages as my house is getting complete. My bank charges me only the interest until I get possession. Can I pay the Full EMI instead?
Of course you can. Banks don't want you to, largely because it increases the total interest you have to pay.
Banks disburse loans in stages during the construction, and your total loan amount keeps going up. Initially, the loan amount is small, and you are charged only interest, so you get to pay a small amount. But you are likely to be able to afford a larger amount, and where you can so afford it, you must pay back. Doing so will reduce your principal, and a lower principal means a lower interest payout.
Calculations
Let's compare.
Assume both people below take a 40 lakh, 20 year loan. Construction for 2 years, loan is disbursed at 20% every six months, with 20% upfront. Loan interest rate is 10%
Amit: Pays only interest during construction.
Yousuf: Pays full EMI through and through.
Instead of boring the life out of you with figures, I have graphs. Nice lovely looking graphs.
First, the way principal is repaid:
Yousuf takes 188 months to repay, which is about 16 years.
Amit takes 264 months or 22 years. That makes sense - his 20 years begin after construction is done.
Now the boring graph of how much interest is being paid.
The bank loves Amit for paying 56.64 lakhs. Heck, they might even ask him out to a Golfing event, and give him a lovely wall clock with the bank's name inscribed, so that he can get his friends to take a loan.
Yousuf on the other hand pays just 32.12 lakhs. He won't get a silly wall clock but he thinks the 24 lakh difference can buy him a lot of wall clocks. With no advertising.
Hey wait, what about the time value of money?, asks the MBA type. Obviously since Amit is paying over a longer time, won't the value of money be lower in later years, because of inflation? I mean if Yusuff pays more today, that money is more valuable than Amit who pays more tomorrow?
Good question. While money is money is money, it's useful to see if there's still an advantage if you consider inflation will reduce the value of money in later years. After all, a Rs. 1000 paid today hurts less than Rs. 1000 paid in 2001.
So let's provide for an inflation of 8% a year, and then "value" the future cash outflows by lowering the number of "today's rupees" that it costs.
(Assumed 8% inflation or "discount rate")
As you can see, there's a Rs. 10 lakh difference, in favour of Yousuf. While Amit pays Rs. 31.7 lakhs, Yousuf pays just Rs. 21.2 lakhs.
Taxes
There is a difference in "current" taxation laws. In a Pre-EMI situation, all interest paid prior to construction is deductible from tax, but not when you pay it. All such interest is added up to the possession date, and then that amount is divided into five equal installments, to be deducted over five years.
In any year, this interest deduction, for self-occupied property, is limited to Rs. 150,000. (Under current laws)
For both Amit and Yousuf, interest paid in years 3 to 7 (the five years after possession), is already greater than 1.5 lakhs per year. So both of them get NO additional deduction for pre-EMI interest.
On the principal front, the amount deductible is a sum total of Rs. 100,000 for housing loan principal. This is not applicable on the principal portion of the full EMI Yousuf pays. But since the current limits are 100K for principal, and the principal repaid by Yousuf from years 3 onwards (when even Amit gets deduction) is greater than 100K per year, there is no added benefit for Amit (or, in that vein, a disadvantage for Yousuf).
(See Section 24 of the Income Tax Act)
Things may change once the DTC comes into effect. (For example, the current draft of the DTC provides no home loan principal deduction) Therefore I wouldn't do anything differently based on tax law.
Practically, you can afford the Pre-EMI today. Why do I say that? Because if you couldn't afford it, banks won't give you the loan in the first place.
So just pay the Full EMI.
But if you ask me, I would completely avoid buying under-construction properties; it is not worth the pain.
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If any MBA type asks you that question (and, its not a good question if they have seen the non-discounted graph), then… I really don’t know what to say.
Do banks charge something if one pays more than the expected monthly payment? Isn’t that like pre-payment?
05.30.11 at 1:25 PM
Never mind, I didn’t realize its to do with pre-EMI vs full-EMI (sigh.. after picking on the stupidity of a question, I ask one myself). I suppose what I asked applies to the case where one may want to pay more than the full EMI.
05.30.11 at 1:30 PM
Heh. Good point though – while the MBA question isn’t to see if the time-discounted value for amit is lesser, it’s to see whether the difference is “significant”. A 10-lakh figure for someone with an 8% discount rate is significant of course. But for someone who values cash higher (that is, can get a higher return on cash today) the difference may be less significant.
In this example for instance, a wild input of a 100% discount rate (say a very successful businessman who can use the money) the difference is just 68K in current rupees, which the guy might say heck, I’ll earn that much with the cash I don’t pay up.
05.30.11 at 2:26 PM
ok, that’s different from adjusting both curves for inflation. Then you would probably want to use different discount rates or, maybe solve for the rate at which discounting the pre-emi curve makes it edge below an inflation-discounted full emi curve. If one can earn that rate then it makes sense to go with pre-emi.
Actually, now I am confused about how this is setup. I’m not sure I understand why the interest paid is the opportunity capital that is being discounted…
05.30.11 at 3:58 PM
It’s not the interest paid. The cash outflow in the first two years is significantly lower for Amit compared to Yousuf. To eyeball, the first year is around 1.5L, if that excess cash can yield me substantial returns, it might override the need to pre-pay principal.
Technically the return on capital required is just 10%, but people like the idea of it being “significant” – that is, a figure high enough that they would care.
05.30.11 at 4:43 PM
There is another concept which builders want you to take, and that is ADF (ADvance Disbursement of Funds). They sell it to buyers saying that your EMI will start immediately. Here, the bank pays the entire amount to the builder, instead of slabs, and the EMI starts off for the buyer. You should clarify that this is not what you mean, and that it is dangerous (financially) to do so.
05.30.11 at 1:46 PM
Hey, there is some mistake either in writing or 1st graph….because you said amit is paying in 188 months/16 years…but graph shows yusuf is taking that much time….do correct it.
05.30.11 at 3:58 PM
Spotted a mistake.. You say “Amit takes 188 months to repay”, but the graph shows it the other way around.. Confusing!
05.30.11 at 4:01 PM
Thanks (and to Kunal also) – Fixed.
05.30.11 at 4:43 PM
Eyeopener!
Thanks!
05.30.11 at 4:46 PM
The whole idea of a 20 year loan itself is wrong.Yes, the calculation part is fine, the difference between the two options is fine, but taking such a long route with no FIXED policy framed for such a long period, one will be at the losing end.Also, you have not taken the EARNING CAPACITY in the coming years into consideration.
The computation suggests going for a 15 or 20 year long term(However you call it).why can’t it be closed within 5 to 10 years so that instead of creating one asset, you can really create two or even more?????
05.31.11 at 9:55 AM
What about the appreciation of the house property over time and the potential rental income it can bring – or does it matter?
By closing the loan earlier, Yusuf also gets to sell the property earlier if required, would that make any difference?
05.31.11 at 11:26 AM
Bala: nope – he can rent it out anyhow. Appreciation, for living in your own house, is a waste. House can be sold anyhow – the bank will of course demand their piece of the pie first, that’s all.
05.31.11 at 11:30 AM
Exactly.Since the bank’s appetite should be satisfied first, let its pie as small as possible.
Come on Mr.Deepak, Why encouraging people to be slaves for a 20 year period and be satisfied with an asset that they never owned?Suggest some alternative.An employee starts earning in his late twenties, and be hounded upon for a forcible BONDED LABOR for 15 or twenty years, and down the memory lane, what he could understand?That he was royally……..
05.31.11 at 12:07 PM
Why bonded labour? Choose to rent! It’s way cheaper. And a simple alternative. The money you save is useful to buy a house when the housing market crashes. Oh, it will crash.
05.31.11 at 12:36 PM
If Amit would have invested the “Emi-Pre-Emi” that he saved during the first 2 years in MF yielding 12-15% for 16 years, he would have got hell lot of money and in a better shape than Yosuf
05.31.11 at 2:21 PM
“MF yielding 12-15%” – sure, but there is no such guarantee at all, and if it falls 12-15% in two years, Amit is hosed. Anyone who assumes 12-15% a year over a two year time frame is in for a big surprise. From Jan 2010 to now, the total return, in about 17 months, is a measly 3%. 12% a year might have happened in the last few years, but it’s not a given!
05.31.11 at 2:47 PM
I meant 12-15% CARG for 16 years.
06.01.11 at 8:55 AM
Ah, true. Maybe that is achievable (or not!). But useful point to consider, of course.
06.01.11 at 10:19 AM
This is the problem with us.We know the problem, and still encourage others to fall prey for the market gimmics.
do you know the gravity of the statement “buy house when the market crashes”???
You still want the readers to continue the “Frog in the Well” loopline!
It is a known fact that whether the market crashes or soars, the real estate companies will never incur losses.If so , it is only notional.The share price will come down, but still they have their assets in hold.Second, the banks will never reduce their pie, and as you suggested, encourage long term commitments.
WHy can’t an employee allowed to think like a businessman?
05.31.11 at 2:37 PM
Sir, if you’ve been around longer than 14 years, you will remember the last crash. There was no “hold” – it was mad and insane selling. Hundreds of RE companies went bust. Like they will now also.
What is this deal about employee/businessman? The concept applies to everyone!
05.31.11 at 2:45 PM
You mean to say when Harshad Mehta’s scam revealed, people bought houses like hot cakes and got benefited?
The real estate or any company for that matter works for a profit.Living in one’s own house is an emotion.From Sri 420 to present day…….(Let’s not name any specific company), the concept remains same.LOOT! And the bigger, the better.
By the way, I hope Deepak is not writing this article on behalf of RECs or Banks for that matter.
The other day the Government claimed that there is a 25million extra homes needed.Of these 25 million, how many will be handed over to these REC?
If you remember well, last year, DLF sold a piece of land for around Rs.1000Cr.The accountants of these days are far intelligent than in those days.Now even if the share price rock bottoms, none of your RE companies will have a concern.They all play safe.The losers are aplenty though! You and be who bough those shares at a premium, every TDand H who fall prey for those BIG ADs, saying everything they offer is Mmmmmmmgnificient……what not!
Welocme to the modren RAJKAPOOR!
Who cared about the RE company? I need a home that I can afford.
05.31.11 at 3:00 PM
dear shri deepak ji,
i would like to point out the taxation aspect in this particular issue, i.e. about the deduction one gets against the housing loan repayment.
if i am not wrong the specific deduction is allowed against the Income chargeable under the head “Income from house property” & no ‘ongoing or incomplete’ project can be considered a ‘house property’. so in my view, to get a tax deduction, the project should be completed, it shoud get a completion certificate from the local authorities.
pls. advice.
so could you pls. throw light on this ?
06.01.11 at 12:40 PM
Deduction is allowed only after possession (which is usually when you get the completion certificate) That means even if you pay EMI or Pre-EMI no deduction is allowed until after you get that certificate. (You’re right, that’s also what I’ve been saying)
06.01.11 at 1:53 PM
No response means either not interested or no answer!
06.02.11 at 11:49 AM
You’re going around in circles mate. I don’t even know what you’re asking – it looks like you’re making statements. Can you rephase? To your allegation that I’m writing on behalf of RE companies, that is just hilarious so I’ll leave it to the world to decide.
You can live in a home you can afford to rent. Usually that’s a better house than you can afford to buy. Why do you have to own it? Leave such notions behind, and rent!
06.02.11 at 12:14 PM
I said I HOPE YOU ARE NOT WRITING ON BEHALF OF THEM and you took it as a statement! even as allegation! and even hillarious!
Funny! I thought I was following a blog that was so much informative and open minded.Sorry if you got hurt!
06.02.11 at 12:47 PM
Deepakji,
Now is the right time to write to comment about the Greater NOIDA Conspiracy
07.12.11 at 11:08 AM
I feel that banks are charging you twice in case of pre-EMI. This is my logic. Please see if there are any flaws. We take a loan and pay interest for the amount of time we hold the load. Now, while property is under construction all we are are doing is taking that loan in “tranches” (I am using this finance word as it gives a kick and makes this argument more professional/ MBA types) or in stages based on progress of construction.
Now, why not treat each of these loans as separate loans and let the loan period start on each of them separately? Think about it. The math would be quite different. And which is how it should be. Why should i be paying EMI again on the first years of under construction when I have already paid some interest on it again?
Assume a 10 lakh loan that is disbursed in 5 installments of 25% each over period of 2 years. Which is 2.5 lakhs per 6 months or 5 Lakhs per year until construction ends. Now, the interest calculation should be like this (Assume start date as X, Years = 20):
First 2.5 @ interest Rate for 20 Years – EMI starts X for 240 months
Second 2.5 @ interest Rate for 20 Years – EMI starts X + 6 months for 240 months
Third 2.5 @ interest Rate for 20 Years – EMI starts X + 12 months for 240 months
Final 2.5 @ interest Rate for 20 Years – EMI starts X + 18 months for 240 months
Thus, the loan will be paid in four stages at different times.
Isn’t this how it’s supposed to be? Banks are looting us by asking us to pay for extra trailing months at the end of 3 cycles above if they take pre-EMI from us.
Thus full disbursement and start of full EMI is correct where banks are not able to cheat…
If we can calculate it this way, I am sure we would be paying much less…
Anything wrong with this logic? Not sure why people and regulators don’t think this way.
06.02.11 at 1:19 PM
What you said is logically correct.This way, you can buy 5 houses instead of one.But is it legal?Will the government allow?How the banks have to be convinced for such a loan?
On the other hand, Since the payment is in tanches, how the OWNERSHIP is to be transferred?As long as the loan is existing, the bank will be the de-facto owner of the house and the “OWNERSHIP” document will be handed over after clearing the loan.Sorry, it is my humble opinion and not a statement!Please ignore any inconvenience! I am just sharing my thoughts
06.02.11 at 3:02 PM
With rising Interest Rates, it is always advisable to pay Pre-Pay the EMI’s.
Moreover, nowadays most of the Banks dont even panalise you for pre-payment if the payment is made from own funds and not by taking loans from some other Bank.
06.21.11 at 11:44 PM
Hi
Will d scenario be same if I am betting on appreciation of under construction project in 2 years and plan to exit? Should I just go for pre-emi in such case??
If flat is worth 45L and I take const linked loan. I pay first 20 pct from pocket and then take loan as it’s demanded in tranches. For this should I take pre emi or full emi? If after 2 Years flat is 55 L and I sell, which case will I benefit more.
Note – am talking about pure investment here. Don’t want to stay in that house.
06.27.11 at 6:31 PM
I am not sure that the argument against Pre-EMI is entirely justified. If the intent is to prepay the loan and the loan is used as a bridge finance, than an only interest with principla payment at the end is what a Pre-EMI option allows. So what this means is that I pay Pre-EMI for abt 2 yrs as construction progresses and on completion, I pay the principal o/s to the loan company and close my loan. If I am able to generate a return on the substituted funds in excess of my interest cost, thats a good think to have isnt it and surely if Im smart that could be done
07.15.11 at 1:14 AM
Hi friends, I had a question , I want to buy commercial property around 60lakhs and I want to know in what way i will pay less interest to the bank.Whether, if I take EMI for more months or less months.And ,if I pay total amount before the tenure, do i need to pay interest for all the years?
07.19.11 at 2:54 AM
Thanks deepak, that was vvery helpful. YOu suggested not to go for under construction properties. In my case it was only affordable thing i could do to get a house in mumbai.
07.26.11 at 8:31 AM
Yes, that’s unfortunately the case, but I suspect that in the coming years things will get much more affordable.
07.26.11 at 11:51 PM
people buy under construction houses/flats for lower prices (e.g.5500/- sq.ft. )then a ready flat (9500/- sq.ft.) which is adjusted by the interest paid.
07.27.11 at 5:17 PM
Deepak,
I am going to take a loan of 27 Lakhs from SBI. I will get possession sometime in last quater of 2012. If I opt for pre- EMI and pay (Full EMI – pre EMI) towards principle, will it be the same? or for this case also its better to for Full EMI?
08.24.11 at 12:28 PM
You can easily calculate this using the data you have (rates plus how much principal you will cut by paying full EMI) It’s always better to opt for Full EMI…
08.24.11 at 7:41 PM
Hi Deepak,
I want to know how much of interest I will pay to the bank if I opt for full EMI from Day#1 and Pre-EMI for say a certain period Months for a Property under construction
Example:
Loan Amout: 30 L
Int Rate: 11.25
Term: 15 Years
Possesion” June 2014 (Add 6 Months delay)
Loan amount disbursed in Installaments
Option#1: Start EMI from Day #1
Option #2: Pre-EMI for 6-12 Months and then Full EMI (Not sure if this kind of a option is available at all).Also not aware of Interest rates for Pre EMI
Questions:
1) I want to know how can I calculate the Int I pay in each of the options for Comparision
2) Also some Developers offer some % discount if you do an upfront Payment. How does this option work?
08.28.11 at 9:22 PM
Deepak,
Even i have the similar question.
I want to know how much of interest I will pay to the bank if I opt for full EMI from Day#1
and Pre-EMI for say a certain period Months for a Property under construction
Example:
Loan Amout: 65 L
Int Rate: 11.25
Term: 20 Years
Possesion” Jan 2015 (Add 6 Months delay)
Loan amount disbursed in Installaments
Option#1: Start EMI from Day #1
Option #2: Pre-EMI for 6-12 Months and then Full EMI (Not sure if this kind of a option is available at all).Also not aware of Interest rates for Pre EMI
Questions:
1) I want to know how can I calculate the Int I pay in each of the options for Comparision
2) Then what is tranche ?
10.02.11 at 6:37 AM
In the context of Gurgaon:
Buy under construction property using pre-emi scheme from a reputed builder at a right location.
Sell this property after 2 years (it is still under construction but nearing completion) with premium. Repay the loan and enjoy the premium.
What is wrong with that?
11.04.11 at 7:18 PM
Hi Deepak,
In your example both the guys are starting a loan for 20 years.
but,
1. How come in the graph, Yosuf finishes the loan in 16 years?
2. Given that Yosuf’s EMI for 1-20 yrs will be same as Amit’s EMI after 2 yrs, Yosuf cannot finish the loan by 16 years?
can i have your opinion on this article, which says Pre-EMI is better,
http://www.rediff.com/getahead/2006/jul/03loan.htm
12.03.11 at 2:53 PM
Because the loan is not fully disbursed while full EMI is paid through construction also. That reduces tenure since the interest component is lesser and the full EMI reduces principal while the full loan is not yet disbursed.
You don’t have to go for advance disbursal. You can tell the bank to disburse in phases while you pay the full EMI!
12.03.11 at 8:59 PM
Hi Deepak,
I have similar question as Praveen. In your example, you mentioned that Yusuf completed the loan in 16 years. That may be applicable to Amit as well and if he did repay in 16 years (just like Yusuf did), the total term for Amit would be 18 years, not 22 years.
You are comparing apples to oranges in this example to make the difference large. The terms should match for a correct analysis.
In the end, I don’t think the difference would be that large. May be 3-4 lakhs.
Thanks,
Anil
12.14.11 at 8:29 PM
My answer is the same :) Yusuf prepays more principal so he has less left to pay for the time after possession. For Amit, there is the full interest during pre-EMI and then full EMI for the subsequent 20 years. The point is that terms don’t match because the principal is whittled down early on.
To get a similar result with Amit, he has to make a bulk payment to cut down principal at the time of possession. This is similar to having paid full EMI in the first two years itself.
The difference, as I’ve demonstrated, is massive!
12.14.11 at 10:37 PM
Hi,
There is one fundamental flaw in your calculation.
>> Amit takes 264 months or 22 years. That makes sense – his 20 years begin after construction is done.
Above statement is wrong. The loan tenure is inclusive of pre-emi period (also known as moratorium period). So total interest outgo will be similar in both cases depending on how fast disbursement happens. However, pre-emi can be better option since difference amount saved can be used for pre-payment. This will reduce the tenure, thereby decreasing the total interest payment further.
12.17.11 at 10:04 PM
Loan tenure isn’t inclusive of pre-emi. If you don’t pay back principal loan tenure stretches to the start point of paying down principal. That’s the fundamental reason why Amit takes 22 years to pay back. The interest outgo isn’t “similar” – there is a substantial difference, as demonstrated in the post.
12.17.11 at 11:41 PM
Loan tenure actually includes moratorium period and in both cases tenure is the same. You can check with the leading PSU bank. (I am not sure about other banks)
Following is example calculation.
Pre-EMI
———-.
Loan amount 30L
EMI 34714
Tenure (including moratorium period) 180 months
Moratorium period 18 months
Rate of interest 10.5%
Total interest outgo during EMI payment: 26,23,644 (180-18 i.e. 162 installments) … (a)
Full EMI
———-
EMI 33,162
Tenure (including moratorium period) 180 months
Moratorium period 0 months
Rate of interest 10.5%
Total interest outgo during EMI payment: 29,69,154 (180 installments) … (b)
Savings in interest amount during EMI payment (b) – (a) = 3,45,510
So this means if we pay 3,45,510 as pre-emi during moratorium period, it is break even in terms of total interest outgo.
Now we will save some amount every month during pre-emi stage since we will not pay full EMI. This amount can be used to pre-pay which will reduce total interest outgo further.
12.18.11 at 12:33 AM
hey, i want to take Rs.8,00,000/- home loan for 12 years @10.5% for under construction property. Possession will be given after 2 years in Dec.2013. In the above case which scheme will be benefited, either pre-emi option or full emi option. Please guide on he same.
12.28.11 at 9:48 PM
Deepak,
We have opted for a house under construction. The bank will be disbursing the amount in installments(i.e 10% at each stage). I wanted to check which option will be better out of these:
1)Paying EMI instead of Pre-EMI or
2)Paying some percentage of amount directly to the developer rather than asking bank to disburse the amount. Here if I pay Pre-EMI, I can save some money and can pay to the developer directly instead of asking bank to disburse for the next installment.
For instance – Payment schedule is as below
-10% at commencement of 1st floor – paid by bank and I am paying Pre-EMI
-10% at commencement of 2nd floor – Along with PreEMI , here i have some money to pay from my end and rest can ask bank to disburse (saved by paying PreEMI instead of EMI).
-10% at time of brick work – paid by bank and I am paying Pre EMI
-10% at etc etc – long with PreEMI , here i have some money to pay from my end and rest can ask bank to disburse (saved by paying PreEMI instead of EMI).
03.09.12 at 5:43 PM