Almost everyone plans to purchase a house before retirement. Given the inflated real estate prices, buying a house outright is not an option for many of us. Thus, many of us have to resort to home loans to finance purchase of house. Though a home loan repayment schedule can be structured in any way, I will discuss two of the most common types of repayment schedules viz. Pre-EMI and Full EMI repayment schedules. I will compare the two methods and see which method is better.
1. Full EMI
You pay the full EMI right after the first disbursement. You pay the EMI as per the sanctioned amount and not the disbursed amount. For instance, you have sanctioned limit of Rs 50 lacs. You have taken a loan for an under-construction property. You have taken disbursement for first tranche of Rs 5 lacs. Even though the disbursement amount is only Rs 5 lacs, you pay EMI based on entire Rs 50 lacs. At 10% for a loan of Rs 50 lacs for 20 years, the full EMI will be Rs 48,251. So, you pay this amount even though the disbursement is only Rs 5 lacs. You can opt for Full EMI even for under-construction properties.
What does this lead to? If your loan is disbursed at one go, there is no difference as the sanctioned amount and the disbursed amount is same. However, if the disbursed amount is lower, your loan gets repaid at a much faster pace. Hence, your overall interest outgo will reduce. If, for any reason, you do not seek disbursement for the entire sanctioned amount, the bank will simply readjust the loan tenor. For instance, if you took first disbursement of Rs 20 lacs and no further disbursement, your home loan will get repaid in 52 months (instead of 20 years or 240 months).
What is the benefit? Your loan gets repaid faster since you are paying both principal and interest. Moreover, since the EMI is as per the sanctioned amount and the interest is calculated only on the disbursed amount, the outstanding principal goes down much faster.
This is only applicable for under-construction properties. As long as the entire home loan amount is not disbursed, you pay only the interest on disbursed amount. There is no principal repayment till such time. Once the entire loan amount has been disbursed, you pay as per regular amortization schedule. In a few cases, the bank may have time limit for Pre-EMIs. i.e., you can pay Pre-EMI up to a maximum of say, three years. Subsequently, full EMI will start.
What does this lead to? If your home loan is disbursed at one go, then there is no difference between Pre-EMI and Full EMI. However, in case disbursement is made in tranches, there will be significant difference. For instance, continuing with the earlier example, you will pay Pre-EMI of Rs 4,167 (Rs 5 lacs x 10% / 12) after first disbursement of Rs 5 lacs. Suppose, after 6 months, you take another disbursement of Rs 10 lacs, your EMI will increase to Rs 12,500 (Rs 15 lacs x 10% / 12).
|Timeline||Disbursement Tranche (Rs.)||Total Disbursement Till date (Rs.)||Pre-EMI (Rs.)||Full EMI (Rs.)|
|First disbursal||5 lacs||5 lacs||4,167||48,251|
|6 months||10 lacs||15 lacs||12,500||48,251|
|12 months||10 lacs||25 lacs||20,833||48,251|
|18 months||10 lacs||35 lacs||29,167||48,251|
|24 months||15 lacs||50 lacs||48,251 (EMI)||48,251|
You can see the EMI starts only after the final disbursal. In the 24 months (time between first disbursal and last), you will have paid interest of Rs 4 lacs (4,167 x 6 + 12,500 x 6 +20, 833 x 6 + 29,167 x 6).
What are the issues? The entire amount (before complete disbursal) goes towards the interest payment. You can see that amount of Rs 4 lacs has gone towards interest payment. Nothing goes towards principal repayment.
In the above example, in case of Pre-EMI option, your principal outstanding at the end of 24 months is still Rs 50 lacs. However, in case of Full EMI, your home loan outstanding at the end of 24 months will only be Rs 41.5 lacs. In this example, the Full EMI Loan will get repaid in 177 installments. On the other hand, under Pre-EMI option, you will take 22 years or 264 months (2 years of Pre-EMI and 20 years of EMI).
Total Amount paid in Full EMI = Rs 48,251 x 177 = Rs 85 lacs
Total Amount paid in Pre-EMI = Rs 4 lacs (Pre-EMI) + Rs 48,251 x 240 = Rs. 1.2 crores
Hence, in the above example, you will pay additional interest of ~ Rs 35 lacs in case of Pre-EMI option. The difference is only in terms of absolute interest. The cost of loan is same in both the cases. Under Pre-EMI, you pay more interest because you are in the loan for a much longer period.
What are the benefits?
- It reduces the burden on your pocket since you pay the interest only on the disbursed amount.
- In case of full EMI, you would have paid Rs 11.58 lacs towards your home loan commitment before possession. In case of pre-EMI, you have paid only Rs 4 lacs.
- Affording house rent and Full EMI may not be easy for everyone. If you are staying on rent and Rs 11.58 lacs (as in the above example) is difficult to afford in the two years, Pre-EMI is a good option.
- Since the last disbursal is typically linked to possession of the house, you pay interest and rent till such time you get possession of the house. Once you get the possession of the house, you can move into the house and stop paying rent (or put your house on rent to generate extra income). Hence, pre-EMI option can be easy on your pocket.
What about Tax Benefits?
Not much to differentiate. There are no tax benefits for housing loan repayment before you get the possession. The benefit for principal repayment under Section 80C is capped at Rs 1.5 lacs per financial year. Tax benefit for interest payment under Section 24 is capped at Rs 2 lacs for a self-occupied house (no cap for let out property). As mentioned earlier, these benefits are available after you get possession of the house.
The benefit for principal repayment done before possession can’t be adjusted later. However, in case of interest payment, the interest paid during the under-construction period (before possession) can be added up and divided in five equal installments. These 5 installments can be claimed as deduction under Section 24 over the next five financial years.
In this case, let’s consider for self-occupied property. In the example considered in this post, the principal repayment for all the years (apart from Pre-EMI) exceeds Rs 1.5 lacs.
|Year||Principal Repayment||Interest Payment||Principal Repayment||Interest Payment|
There is no tax benefit in the years 1 and 2. You can see principal repayment for Full-EMI is always greater than Pre-EMI. Hence, there is no excess benefit for principal repayment in Pre-EMI option. Interest payment in the years 3 to 7 is greater than Rs 2 lacs in both the cases. Hence, no additional benefit for interest paid before possession. To be honest, there is not much to differentiate between the two options in terms of tax benefits. Other cases (different values of loan amount, tenure, interest rate) may throw up a slightly different result. But not too different. In my opinion, tax benefit is unlikely to be a major decision maker between Pre-EMI or Full EMI.
Which Is Better?
I prefer Full EMI as you repay principal from the very beginning and thus the loan gets repaid faster. And you pay lesser absolute interest cost. In case of Pre-EMI, in case of delays in possession, you may have to keep paying Pre-EMI for an even longer duration. This brings to an even important decision about whether you want to go for an under-construction property. But this is an altogether different discussion. However, do consider affordability of Full EMI.
If you can’t afford Full EMI (along with rent), you will have to go for Pre-EMI.