# Loan Moratorium: Impact of Potential Interest on Interest Waiver

On the account of Covid-19 related lockdown and associated financial stress, RBI had offered loan moratorium to borrowers. We checked in some of our earlier posts how availing loan moratorium provided immediate relief but increased your liability (same EMI but longer tenure OR same tenure but higher EMI).

A component of increase in liability was due to compounding of interest.

Related Reading: EMI Moratorium Math Explained

## How Does Compounding of Interest Work during Loan Moratorium?

You start with a loan of Rs 1 lacs at the interest rate of 12% per annum or 1% per annum.

In the first month, the interest component will be Rs 1 lac X 1% = Rs 1,000.

If you had availed moratorium, this unpaid interest got accrued and added to your outstanding principal amount.

Thus, after the first month, your outstanding will be Rs 1.01 lacs.

In the second month, the interest will be charged on the original principal (Rs 1 lac) and the accrued interest (Rs 1000).

Hence, the interest for the second month will be (Rs 1 lac + Rs 1,000) * 1% = Rs 1,010.

In this way, you are being charged interest on interest. Here is an illustration.

 Loan Amount 1,00,000 5,00,000 30,00,000 50,00,000 Interest Rate 12% 9.0% 9.0% 9.0% Remaining Tenor (months) 12 60 180 240 EMI ₹8,885 ₹10,379 ₹30,428 ₹44,986 Monthly interest rate 1.00% 0.75% 0.75% 0.75% Interest for the 1st month 1,000 3,750 22,500 37,500 Principal O/s at the end of 1st month 1,01,000 5,03,750 30,22,500 50,37,500 Interest for the 2nd month 1,010 3,778 22,669 37,781 Principal O/s at the end of 2nd month 1,02,010 5,07,528 30,45,169 50,75,281 Interest for the 3rd month 1,020 3,806 22,839 38,065 Principal O/s at the end of 3rd month 1,03,030 5,11,335 30,68,008 51,13,346 Interest for the 4th month 1,030 3,835 23,010 38,350 Principal O/s at the end of 4th month 1,04,060 5,15,170 30,91,018 51,51,696 Interest for the 5th month 1,041 3,864 23,183 38,638 Principal O/s at the end of 5th month 1,05,101 5,19,033 31,14,200 51,90,334 Interest for the 6th month 1,051 3,893 23,357 38,928 Principal O/s at the end of 6th month 1,06,152 5,22,926 31,37,557 52,29,261 Tenure kept constant but EMI changed EMI for the increased principal (New EMI) 9,431 10,855 31,823 47,049 Increase in EMI 547 476 1,395 2,063 Total excess payment over the loan tenure 6,559 28,555 2,51,135 4,95,053 EMI kept constant but Tenure changed No. of EMIs required to repay the loan 12.8 63.5 198.7 274.9 No. of Extra EMIs to be paid 0.79 3.52 18.66 34.92 Total Excess Payment over the loan tenure 6,994 36,505 5,67,723 15,71,087

Nothing wrong with this. This is called compounding of interest. And that’s how loan calculations work. In fact, that’s how your bank fixed deposits work. You interest income gets compounded. Hence, not many questioned this compounding of interest (interest on interest) during loan moratorium.

Further Reading: With Loans, the Power of Compounding Works in Reverse

One gentleman differed. Gajendra Sharma, a resident of Agra, petitioned to the Supreme Court of India that interest should not be charged on loans during the moratorium period. If that’s not possible, at least the interest on interest should not be charged. After all, the Government locked the economy down. There is little the borrowers could do.  And if the banks charge interest on interest (compound interest), it is no relief. You are providing the relief now but the repayment burden will increase sharply once the moratorium is over.

I will not go into the legal and financial merits of the case but the “interest on interest” argument found favour with the Supreme Court and the Government was asked to look into this. There is news of “interest on interest during the loan moratorium period” to be waived. Or rather the Government will bear of the burden of such compound interest for loans under Rs 2 crores. I will write about this when the final guidelines are issued.

However, it is still interesting to understand the potential impact.

In the example considered above, the interest was Rs 1,000 for the first month, Rs 1,010 for the second month, Rs 1,020 for the third month and so on. If the compound interest (interest on interest) was waived (or Government took the burden), the interest for each of the 6 months will be Rs 1,000.

 Loan Amount 1,00,000 5,00,000 30,00,000 50,00,000 Interest Rate 12% 9.0% 9.0% 9.0% Remaining Tenor (months) 12 60 180 240 EMI ₹8,885 ₹10,379 ₹30,428 ₹44,986 Monthly interest rate 1.00% 0.75% 0.75% 0.75% Interest for 6 months (Compound Interest) 6,152 22,926 1,37,557 2,29,261 Principal O/s at the end of 6th month 1,06,152 5,22,926 31,37,557 52,29,261 Interest for 6 months (Interest on Interest waiver) 6,000 22,500 1,35,000 2,25,000 Principal O/s at the end of 6th month 1,06,000 5,22,500 31,35,000 52,25,000 Interest on Interest 152 426 2,557 4,261 With Compound Interest EMI for the increased principal (New EMI) 9,431 10,855 31,823 47,049 Increase in EMI 547 476 1,395 2,063 Total excess payment over the loan tenure 6,559 28,555 2,51,135 4,95,053 With Interest on Interest Waiver EMI for the increased principal (New EMI) 9,418 10,846 31,797 47,011 Increase in EMI 533 467 1,369 2,024 Total excess payment over the loan tenure 6,397 28,024 2,46,467 4,85,852 Difference Between Compound Interest and Interest on Interest Waiver Difference in EMI 13.51 8.85 25.93 38.34 Difference over the loan tenure 162 531 4,668 9,201

As you can see, there is not much difference. While you save some money over the loan tenure, the savings are not stark. For instance, for Rs 50 lacs (20-year loan at 9%), EMI went up from Rs 44,986 to Rs 47,049 after accounting for compound interest. If compound interest was waived during the moratorium period, the new EMI would be Rs 47,011. A difference of only Rs 38 per month. Over 20-year loan tenure, that’s a difference of just Rs 9,201.

In my opinion, not much difference between compound interest and interest on interest waiver. Note that the difference could have been bigger if the moratorium was for a longer period.