The interest rate is a major component of home loans. It is this component that determines the actual cost of a house when one breaks down the total payment made to the bank into principal and interest. It is worth pointing out that if one sums up the EMI, one would find that the total payment exceeds the cost of the house by a large margin. Some people might be flummoxed by the total payback amount, especially if the payment tenure is large.
It is not surprising though that the bigger the payback tenure, the more money a person pays back. However how can the difference between the amount borrowed and the total amount paid back be explained?
The Unexplained Large Payback
When the banks calculate the EMIs, they do not merely take into account the payable interest that should come back to them with the principal sum. Over time, due to inflation, the value of money decreases.
We can understand it by remembering the price of goods a decade earlier; which were lesser when compared with the prices today. This is because, the value of money decreases with time and more of it is required to purchase the same quantity of goods.
The current value of money is called the Present Value and this amount is much more valuable in future. The present value is depreciated year on year in accordance with predefined rates. The rate of inflation is used to calculate the value of payments in future; and that value is called future value of money.
What Adds to the Sum?
The EMIs however are fixed. Unless one has opted for the floating interest rate, the amount payable every month is an exact number as calculated using fixed interest rate. What people do not see is what they would pay in future. That amount would have a lesser value then.
This is why banks and lending institutions calculate the EMIs in such a manner that in the long run applicants are able to match the value of the principal and the interest; having taken into account the depreciation resulting from inflation and other factors. So even if the sum of EMIs is much more than the actual amount of loan, the total payback value actual value is not much different from the principal amount.
One can verify it by calculating the future value of the principal amount using standard inflation rates. Therefore irrespective of whether a person opts for floating rates or fixed rates, the total amount to be paid back will invariably be huge. One can use housing.com’s home loan guide to know the benefits of each.
The guide would also help the applicants realize that both the options have their pros and cons but neither has much bearing on the actual amount payable. The only question remains in case of floating rates is how much can a person save?
It is also worth pointing out that initially the components of the EMI have a larger share of the interest and a smaller share of the principal. This share starts to gradually eat into the interest and incorporates more of principal. This is why one sees that later on during the loan tenure, the total principal amount suddenly starts depreciating faster.
In Conclusion
Housing.com provides detailed explanation of all factors that go into making of home loans. Anyone who wants to learn more can visit the portal and access the guide.
