Home Loan Prepayment Interest calculation is one of the grey areas from the borrowers perspective. As the average Home Loan tenure in India is 7-8 years therefore Home Loan Prepayment is very common. Borrower prepays Home Loan as and when he/she receives an annual bonus or on the maturity of the past investment. Instances of overpayment, wrong effective date, calculation of Prepayment Interest etc are common points of dispute with the Home Loan Provider. In my post, Home Loan Prepayment – 5 Important Points, i discussed the general points. Based on the feedback/queries of my readers, i decided to write a post on How the Home Loan Prepayment Interest is calculated?
Though the calculation of Prepayment Interest is not a rocket science but the staff of a Bank/HFC fail to explain the same to the borrower. Before we move to Prepayment Interest calculation, it is critical to understand the following points.
1. Monthly Rest: Rest is basically the period at which the outstanding principal amount is calculated by the bank. Though not many borrowers pay attention to this Home Loan Parameter. By default, almost all the Floating Interest Home Loan’s are disbursed with Monthly Rest clause. Only exceptions are some special Home Loan products like SBI Max Gain, Citibank Home Credit, SCB Home Saver, HSBC Smart Home and IDBI Home Loan Interest Saver. The rest for these special products is Daily i.e. Interest is calculated on daily reducing balance.
In short, Monthly Rest implies that Bank will re-calculate the outstanding principal amount for interest calculation every month. Normally this date is 1st of every month. Therefore, we can conclude that Borrower is charged interest on the principal outstanding as on 1st day of that particular month. This date will be considered as the reference date for calculation of Home Loan Prepayment Interest. Any re-calculation of principal outstanding can be done only on this date i.e. 1st of every month.
2. Date of Payment: Another major bone of contention between the borrower and the bank/HFC. In one of the case, i observed that one of the leading HFC considered the date on which the cheque was en-cashed as the date of payment. It is legally wrong.
“Under the Negotiable Instruments Act, 1881. Subsequent legal interpretation by the Honorable Supreme Court of India, a cheque is an instrument negotiated by delivery. Which implies when the cheque is tendered/deposited, there is a presumption that payment would be realized in due course of time hence the date of cheque deposit is considered to be the date of payment irrespective of the fact when it is actually presented for payment. Date of cheque deposit is considered as date of payment similar to cash payment“
In short, if you are depositing a cheque to prepay Home Loan on 15th of the particular month then your date of payment is 15th. Prepayment Interest will be calculated from 1st to 14th of the month.
3. No of EMI’s vs Revised EMI: As i highlighted in my other posts also that at the time of Home Loan prepayment, the borrower has an option to reduce either No of EMI’s or EMI amount. By default, the bank will reduce no of EMI’s but if you would like to reduce EMI amount then you can submit written application at the time of Home Loan prepayment. In this case, your no of EMI’s will be same before and after Home Loan Prepayment. Your Monthly EMI amount will be reduced. Personally, i prefer to reduce No of EMI’s as it will reduce your interest outflow thus reducing the net cost of the property.
4. Date of EMI Debit: Date of EMI debit has no co-relation with the Prepayment Interest. Assuming, my monthly rest or date of re-calculation of principal outstanding is 1st of the month. My EMI is debited on 5th or 10th of the month, but this date has no relevance as such. Normally borrowers get confused and assume that EMI is calculated on the date of EMI debit.
5. EMI is not paid in Advance: This is another major confusion because of which most of the borrowers end up paying an extra EMI. General perception is that EMI deducted in May’15 is for the month of May’15 which is not true. The EMI for April’15 will be deducted in the month of May’15.
Calculation of Prepayment Interest
Let’s check out how the prepayment interest is calculated with an example. Assuming, i am a borrower and my principal outstanding as on 1st May, 2015 is Rs 30,00,000. My Home Loan Interest rate is 10% and EMI amount is Rs 50,000. No of EMI’s due is 84.
Now, during the month i decided to prepay Rs 5,00,000 through cheque towards principal outstanding on 18th May, 2015. In this case, my date of payment will be considered as 18th May, 2015. For calculation purpose, the reference date of prepayment interest will be 1st May, 2015 i.e. date on which principal outstanding was last calculated. Based on principal outstanding as on 1st May, 2015, the interest for the month May, 2015 will be calculated. The EMI of Rs 50,000 for April’15 was debited from my savings account on 5th May, 2015.
If i prepay Rs 5,00,000 on 18th May, 2015 then my principal outstanding will be re-calculated w.e.f 1st May, 2015. In short, principal outstanding will be revised to Rs 25,00,000 as on 1st May, 2015 instead of Rs 30,00,000. As the date of payment is 18th May, 2015 therefore Bank will charge Simple Interest on the prepayment amount i.e. Rs 5 lakh from 1st May to 17th May (Excluding the Date of Payment). In this case @10% SI, prepayment interest will be Rs 2361. Therefore, i will hand over 2 cheques to the bank
(a) A cheque of Rs 5 lakh towards principal prepayment
(b) A cheque of Rs 2361 towards prepayment interest (Simple Interest)
Bank or HFC can re-calculate the principal outstanding during the month because EMI for the current month is due on 5th of next month. After Home Loan Prepayment, by default no of EMI’s will reduce from 84 to 65. If you wish to retain no of EMI’s to 84 & reduce EMI amount then you can submit written request for the same. Your EMI will be reduced from Rs 50,000 per month to approx Rs 41,750.
To summarize, it is important to understand how the Home Loan Prepayment Interest is calculated. Banks and HFC’s follow different criterion which can be challenged. As the home loan amount is a big liability, therefore, slight manipulation of calculations may cost you few thousand rupees very easily. Home Loan Prepayment Interest will be NIL if you prepay Home Loan on the 1st of the month :)
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