How do Banks Calculate Interest on Home Loans?

Interest Rate on Home Loans

All who have taken home loan and everyone who is planning to take a home loan in the near future will be keen to know how banks calculate interest on home loans. This piece of article is here with answers for all your questions related to calculating interest on home loans. Equated Monthly Installment (EMI) is the combination of amount which is part of principal loan amount for repayment plus rate of interest on the home loan.

Just like basic mathematics, banks use specific formula to calculate rate of interest and EMI on the home loan. This is considered on the basis of eligibility of the loan applicant such as their age, income capacity, job consistency, industry in which they work, secured or unsecured loans, loan amount required and most importantly CIBIL score.  If the applicant has CIBIL score more than 700 then the rate of interest on the loan will be comparatively lower. Apart from these some of the other expenses the loan applicant will have to bear are processing fee, pre-closure charges, and documentation charges and so on.

Formula for calculating rate of interest and EMI on home loan:

E = P x r x (1+r)^n/((1+r)^n – 1)

Here:

E is the monthly repayment amount the loan applicant will have to pay every month on the loan amount

P is the principal amount that the borrower would like to borrow.

r is the rate of interest applicable on the loan amount however it is calculated on a monthly basis rather than calculating on annual rate of interest. This is determined using the formula r = (annual interest/12) x 100.

n is the tenure of the home loan in terms of number of months. So if the tenure is 5 years the number of months will be 60.

One of the most basic formula used for the calculation of rate of interest and EMI on home loan is the above mentioned one.

In most of the cases the first month EMI will not reflect the actual figure as this might include processing fee, documentations charges and certain other charges. All loan borrowers have the right to check with their banks how interest on home loan is calculated. Banks are obliged to share this piece of information to its customers upon request. Before checking with the bank directly, go through their terms and conditions. At times the calculations and other related expenses will be already stated in terms and conditions of home loan.

Let’s take an example to understand how interest is calculated on home loans:

Example:

Mahesh takes a loan of Rs.1 lakh with rate of interest of 11% p.a. He has to pay back the loan in 15 years tenure. The formula to calculate loan rate of interest and EMIs is as follows: (Loan amount x Interest/12) x [(1+ interest rate/12)^loan tenure in number of months] / ([(1+ interest rate/12) ^ loan tenure in number of months]-1}

Thus when the formula is implied with figure the calculation will be:

EMI = (100000 x .00916) x ((1+.00916) ^180) / ([(1+.00916) ^180] – 1)

EMI = Rs 1,136.

Note: The rate of interest is 11% per annum which is divided by 12 months to get monthly interest rate which is equal to 0 .00916.

Current Rate of interest on home loans in India:

Bank Name Floating Interest rate Per lac EMI Processing Fee
SBI – State Bank Of India 8.35% – 8.50% Rs.858 – Rs.868 0.35% of Loan Amount or Rs 10000 plus service tax whichever is less, subject to minimum of Rs 2000 plus taxes
ICICI Bank 8.35% – 8.80% Rs.858 – Rs.886 0.50% – 1.00% of the loan amount or Rs. 1500/- (Rs. 2000/- for Mumbai, Delhi & Bangalore), whichever is higher + applicable Service Tax & Surcharge
HDFC Ltd 8.35% – 8.55% Rs.858 – Rs.871 Up to 1.25% of the loan amount or ₹ 3,000 whichever is higher, plus applicable taxes
LIC Housing 8.35% – 8.80% Rs.858 – Rs.886 Zero
AXIS Bank 8.35% – 8.75% Rs.858 – Rs.884 Up to 1% of the Loan amount subject to minimum of Rs.10,000/-
DHFL 8.35% Rs.858 Rs.5,000 to Rs.20000 + document charges + Service Tax

Components considered for home loan EMI calculation are:

Loan Amount: This is the amount which the borrower would like to take for owning a house in India. Based on the borrower’s requirement and property value, loan amount will be determined by the bank. Maximum loan amount is offered only upto 80% of the property value. The rest 20% has to be arranged by the buyer of the property as down payment amount.

Loan tenure or period: The number of years by which the borrower will have to repay the principal and interest on the loan amount is called as the tenure of the loan. This period is calculated as per the eligibility and requirement of the borrower. At times the borrower would be eligible to get loan tenure extension up to 20 years however if he/she prefers to take the loan only for a period of 10 years, bank will sanction loan accordingly.  On the other hand, if the eligibility of tenure is only upto 10 years, the borrower cannot extend the tenure to more than 10 years. Tenure is calculated based on the age and income earning capacity of the home loan borrower.

Loan Interest Rates: This is the amount charged on the borrower by the bank for lending loan amount. The rate of interest is usually determined for per annum basis. If the loan is sanction for Rs. 20 lakhs with tenure of 15 years and for rate of interest of 12%, then it means that the interest rate is 12% per annum for the consecutive number of years.

Having said all these, banks have their own ways of calculating rate of interest on home loans. Thus spend time to speak to your bank representatives on the rate of interest calculation part and also try to negotiate the rate on the home loan. At the end of the day, bank manager has the right to reduce rate of interest on the home loan to a certain extent even if the interest rate is calculated as per predetermined standards.

RBI has set a certain minimum/ base rate for home loans. Banks are not allowed to charge rate of interest on home loans out of these standards set by RBI. Indian Government is promoting everyone to own a house and thus home loans are made more affordable and accessible. There is priority sector lending to whom house loans are made more easily accessible.

 

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