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Why are EMIs initially loaded with interest components?

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Author - Sanyam Jain
Why are EMIs initially loaded with interest components?

The most important word associated with Loans is EMI. Equated Monthly Installments are the monthly payments made by a borrower as a part of the repayment of the loan. These payments include contributions towards the principal amount as well as the interest component.

Initially, the interest component is significantly higher. However, as we progress along with the loan tenure, the interest component reduces and contribution towards the principal repayment increases.

Three factors determine the EMI of a loan:

  • Loan amount: The total amount borrowed by the individual.
  • Interest rate: The rate at which the interest is charged on the amount borrowed.
  • Tenure of the loan: The agreed loan repayment time frame between the borrower and the lender.

When a loan is taken, the borrower is expected to make regular EMI repayments. It is an unequal combination of principal and interest components. A Loan Amortisation schedule breaks down each of these payments based upon interest and principal components. It contains information like the tenure, EMI amount, interest, principal payment and the outstanding loan. If the loan bearer wants to foreclose the loan or wants to refinance his loan, this schedule is beneficial in such cases. This schedule helps an investor examine how the loan is being paid and the loan outstanding.

The type of interest charged on loan is yet another factor which determines the EMI payments. In fixed-rate loans, the EMI payments remain constant during the tenure. However, in floating-rate loans, the interest rates vary based on the prevailing market rates. Hence, the EMI payments also vary whenever there is a change in the base rates.

Another factor affecting the EMI payments is the pre-closure or partial payments made towards the loan. Any partial payments made towards the loan are deducted from the principal amount of the loan. This results in the reduction of the total interest that is to be paid.

The Income Tax Department treats the two components of EMI - interest and principal - separately while offering tax benefits to borrowers. The tax relief on the principal is allowed under Section 80C, whereas the benefit for interest is allowed under Section 24. As a result, the borrowers have to rely on the loan amortisation table sent by the bank to determine the principal or interest repaid. This is because the EMI does not constitute the two components in the same proportion as discussed earlier.

For tax planning, it is essential to find out the cumulative interest and principal repaid over a definite period. Since the maximum tax savings under Section 80C are up to Rs 1 lakh, an idea of the cumulative principal paid in the current financial year helps plan the investments.

So while EMI is initially loaded towards the interest component, it decreases gradually, and the principal amount repaid increases. Among the many factors that determine this interest component, we have discussed a few of the major ones above.

Still have any doubt? Feel free to reach out to us. Contact us at +91-8448389600 or write to us at care@myloancare.in for any clarifications.

About Author

Sanyam Jain
Highly motivated and utterly skilled, a young and zealous writer trying to follow his passion for the love of the English language. Written for different niches for over three years, now writing for the finance sector. When writing for a financial product you learn a new thing everyday.

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