Pre-EMI vs Full EMI – Which is better?

Understanding Pre-EMI Vs Full EMI:

Pre EMI vs EMIWhenever you approach a bank for a loan to construct a home or purchase a property under construction, the funds in most cases, will be released in tranches. Disbursement is usually based on the stage of completion of the project. Consequently, until the time you get the possession of the house or your construction is complete, and the municipal authorities issue the completion certificate, you get an option to service only the disbursed amount of the loan, instead of the full quantum sanctioned. It means that borrowers have to pay only the interest on the amount of loan taken, till they get the possession of the house. This is known as pre-EMI and they precede the actual EMI.

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Pre-EMI Vs Full EMI

The Pre-EMI option is extended to the borrower by the bank, and he/she has to decide whether to avail it or not, after considering the loan mathematics involved.

Let’s consider an example to understand the difference between the two.

The first step will be to familiarize with the formula involved for calculating EMIs.

[P X r X (1+r)^n]/[(1+r)^n-1]

Here, P= the principal or loan amount, r= monthly rate of interest, and n= total number of installments.

Now let us take two scenarios. The first scenario describes the EMI where the bank disburses the entire loan at one go, while the second one describes the pre-EMI, where the bank releases the loan in installments.

Scenario I: Entire loan disbursed

Loan Amount

Rs. 24,00,000.00

Annual interest

10.75%

Loan period (in months)

240

Moratorium (in months)

0

Date of loan

1 January, 2015

An EMI of Rs. 24,365.50 becomes payable immediately. The loan amortisation schedule for the first 10 instalments is as follows:

Instalments

Month

Opening balance (Rs.)

EMI (Rs.)

Principal (Rs.)

Interest (Rs.)

Closing balance (Rs.)

1

01/02/2015

24,00,000.00

24,365.49

2,865.49

21,500.00

23,97,134.51

2

01/03/2015

23,97,134.51

24,365.49

2,891.16

21,474.33

23,94,243.34

3

01/04/2015

23,94,243.34

24,365.49

2,917.06

21,448.43

23,91,326.28

4

01/05/2015

23,91,326.28

24,365.49

2,943.20

21,422.30

23,88,383.08

5

01/06/2015

23,88,383.08

24,365.49

2,969.56

21,395.93

23,85,413.52

6

01/07/2015

23,85,413.52

24,365.49

2,996.17

21,369.33

23,82,417.35

7

01/08/2015

23,82,417.35

24,365.49

3,023.01

21,342.49

23,79,394.34

8

01/09/2015

23,79,394.34

24,365.49

3,050.09

21,315.41

23,76,344.26

9

01/10/2015

23,76,344.26

24,365.49

3,077.41

21,288.08

23,73,266.85

10

01/11/2015

23,73,266.85

24,365.49

3,104.98

21,260.52

23,70,161.87

The borrower has to start paying both the principal and the interest immediately because the bank released the loan upfront.

Scenario II: Loan disbursed in parts

Banks usually gives the loan in 3-6 tranches. But for easy understanding, let’s consider a scenario where Rs. 1 lakh is given every month for the two-year construction period, at a hypothetical monthly interest of Rs. 896 per lakh. The schedule will be as follows:

Month

Opening balance (Rs.)

Amount disbursed
(Rs.)

Pre-EMI for the month (Rs.)

Closing balance (Rs.)

1

Not applicable

1,00,000.00

896.00

1,00,000.00

2

1,00,000.00

1,00,000.00

1,792.00

2,00,000.00

3

2,00,000.00

1,00,000.00

2,688.00

3,00,000.00

4

3,00,000.00

1,00,000.00

3,584.00

4,00,000.00

5

4,00,000.00

1,00,000.00

4,480.00

5,00,000.00

6

5,00,000.00

1,00,000.00

5,376.00

6,00,000.00

7

6,00,000.00

1,00,000.00

6,272.00

7,00,000.00

8

7,00,000.00

1,00,000.00

7,168.00

8,00,000.00

9

8,00,000.00

1,00,000.00

8,064.00

9,00,000.00

10

9,00,000.00

1,00,000.00

8,960.00

10,00,000.00

11

10,00,000.00

1,00,000.00

9,856.00

11,00,000.00

12

11,00,000.00

1,00,000.00

10,752.00

12,00,000.00

13

12,00,000.00

1,00,000.00

11,648.00

13,00,000.00

14

13,00,000.00

1,00,000.00

12,544.00

14,00,000.00

15

14,00,000.00

1,00,000.00

13,440.00

15,00,000.00

16

15,00,000.00

1,00,000.00

14,336.00

16,00,000.00

17

16,00,000.00

1,00,000.00

15,232.00

17,00,000.00

18

17,00,000.00

1,00,000.00

16,128.00

18,00,000.00

19

18,00,000.00

1,00,000.00

17,024.00

19,00,000.00

20

19,00,000.00

1,00,000.00

17,920.00

20,00,000.00

21

20,00,000.00

1,00,000.00

18,816.00

21,00,000.00

22

21,00,000.00

1,00,000.00

19,712.00

22,00,000.00

23

22,00,000.00

1,00,000.00

20,608.00

23,00,000.00

24

23,00,000.00

1,00,000.00

21,504.00

24,00,000.00

Total pre-EMI

2,68,800.00

———-

Average pre-EMI

11,200.00

What it means?

EMI: Rs. 24,365.50 (scenario I)
Average pre-EMI: Rs. 11,200.00 (scenario II)
Difference between average pre-EMI and EMI: Rs. 13,165.50
Even after paying pre-EMI for two years which will amount to Rs. 13,165.50 X 24=Rs. 3,15,972.00. Borrowers will still have to pay the EMI after they get possession, which means Rs. 24,365.50 each month for two extra years, if they have opted for pre-EMI.

What the reality is?

Project delays are the norm in our country with most builders failing to complete their work on time. If you have opted for pre-EMIs, you’ll end up paying interest for a longer duration. While only a few builders offer compensation for a delay in handing over possession, it’s something you can’t bank upon because the money won’t be anywhere close to the EMI you are paying.

Tax on Pre-EMI

Housing loans are governed by two sections of the Income Tax Act. Section 80C, which we all are quite familiar with, especially deals with house property. A principal prepaid before getting the ownership of a property, can’t be deducted under the Income Tax Act, which rules out benefits under the section.

Interest paid before possession, however, is an allowable deduction. Under section 24, interest paid during the period before possession can be divided into five instalments and claimed for five consecutive years for a maximum of Rs. 2 lakhs per year. For a let-out property, there is no upper limit.

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So which one?

Paying EMIs instead of pre-EMIs, always makes financial sense, except in the following cases:

• You are an investor and will sell the property as soon as construction is complete.

• You are cash strapped but expect a rise in income before getting possession of the house.

• You are staying in a rented house while waiting for possession and can’t afford to pay both the full EMI and rent at the same time.

Paying full EMI, ensures that while taking possession, you get the satisfaction of having paid off a part of the outstanding loan, along with the joy of owning the house.

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