Pre-EMI vs Full EMI – Understanding payment schemes for under-construction properties

When you purchase an under-construction property, your bank may link the disbursal of home loan to the construction stages of the property. In such cases, you will either be asked to pay pre-EMI OR given an option to choose between pre-EMI and full EMI payments.

What is Pre-EMI?

As you are probably aware, Equated Monthly Instalment (EMI) consists of Principal and Interest components. Pre-EMI is just the interest portion on the disbursed loan amount that you pay until the full disbursal is done. i.e., your home loan behaves like an interest-only loan on the disbursed amount until the completion of construction. Your EMI payments start after the pre-EMI phase. Until then, your money does not reduce even a paisa of the outstanding loan amount.

Lets consider an example where you are borrowing ₹ 40 lakhs @ 10.5% interest rate with a tenure of 20 years for an under-construction property. Lets say, the bank disburses the loan amount in 4 stages.

As illustrated above, you would pay (8750 x 6) + (17500 x 3) + (26250 x 3) = ₹ 2,36,250 as pre-EMI (interest) towards the disbursed loan amount. Your EMI of ₹ 39,935 for the remaining 20 years starts from 01-Feb (i.e., a month after final disbursal).

Pre-EMI vs Full EMI

Some banks allow you to pay full EMI even when the disbursal is being done in stages. If you choose ‘EMI under construction’ option,  you will start paying EMI from the beginning of construction, but your interest amount will be calculated based on the amount disbursed to the builder and the rest of the amount will be counted towards principal. i.e., EMI remains the same but the principal portion of the EMI would be higher and loan gets repaid quickly.

If you are given a choice between paying pre-EMI vs full EMI during the construction phase, which one should you choose? There are many arguments for and against choosing between pre-EMI and full EMI. Paying full EMI, instead of pre-EMI, makes financial sense in all cases except the following:

• You are a financial expert who is capable of earning good returns consistently by investing the small principal portion elsewhere. Remember that you pay less Principal and more Interest during the initial loan tenure.
• You are an investor looking to sell the property as soon as the construction is complete.
• You are strapped for cash at the moment and expect a salary raise before you get possession of the house.
• You are renting while waiting for property possession and cannot afford to pay both rent and full EMI at the same time.
• You love giving (more) money to the lender for longer duration – the construction period (typically 1-3 years) plus loan tenure (typically 10-20 years).

On the other hand, paying full EMI ensures that at the time of possession, you experience the satisfaction of having paid off a portion of the outstanding loan amount along with the joy of owning a home.

What if the Builder agrees to pay the pre-EMI?

Lenders and builders offer myriad schemes for under-construction projects that are hard to understand for buyers. Note that builders (and lenders) keep coming up with innovative schemes to attract buyers. One such scheme is the 80/20 scheme.

80/20 (or 90/10 or 75/25) scheme

This notorious scheme involves buyer making a 10 – 25% down payment towards the home and the rest is disbursed by the banks / HFCs. RBI took a serious note of Advance Disbursal Facility (ADF) by banks, wherein the developer gets an upfront disbursal of the entire loan amount without any linkage to the construction stages. In most cases, the builder would offer to pay the pre-EMI on behalf of the buyer for a fixed period. RBI advised banks against such borrower un-friendly schemes because a)  it would mean developers getting access to funds at cheaper interest rates and b) buyer would be left to fend for himself if the builder delays (or stops) either the pre-EMI payments or the project itself.

Do not agree to advance disbursal even if this is the only exciting project in town and the builder happens to be your very own Mama or Chacha.

Caution: More than half the projects are delayed

Anytime a builder talks about always delivering on time, show him this metric related to on-time completion of housing projects in various Indian cities. Penalty clauses and cancellation options may be inadequate to protect you against project delays and consequent financial hardship.

Tax considerations

Interest paid, as part of pre-EMI or full EMI, is not tax deductible during the construction phase. Once you get the possession certificate, the interest component of the pre-EMI (or full EMI) is aggregated and deduction is allowed in five equal instalments beginning from the year in which the construction is completed.

For example, if the total interest was ₹ 2,00,000 during the construction phase, you can deduct ₹ 40,000/year for first 5 years from the date of final disbursement.

However, principal amount paid as part of full EMI during the construction phase is not tax deductible.