When you take a loan, you repay it through Equated Monthly Installments (EMIs in short). This is something that everyone knows.
But what a lot of real estate investors are either totally ignorant of or often misunderstand is a concept called Pre-EMI – a highly investor/borrower friendly option of repayment that 8 out of 10 loan borrowers fail to take advantage of. As many of our current investors at G&C too are ignorant of the same, we felt it will be helpful to put up a short article explaining this concept and illustrating its benefits through an example.
When you take a home loan for a property that is still under construction, banks do not release the entire loan amount to the builder at one go or in one single payment. As property is still under construction, banks will release the loan amount only in stages/installments as per progress of property’s construction or as per builders payment schedule.
In such a case of loan taken for property still under construction, banks give you two options or methods of repayment i) through Normal EMIs and ii) through combination of Pre-EMI and EMI.
How is Pre-EMI different from EMI?
EMI : A normal EMI consists of both principal and interest component. Which means, every time you pay a normal EMI, your principal outstanding gets reduced by certain amount.
Pre-EMI : A pre-EMI on the other hand consists of purely interest being charged on the loan and does not include any principal. Which means, every time you pay a pre-EMI, your principal outstanding does not get reduced as you are paying only interest and not repaying any principal.
Below is an example to explain both concepts and the difference between the two.
Mr.Raj purchases a property worth Rs.50 lakhs and goes for a loan of Rs.30 lakhs. As property is still under construction, the bank will release the Rs.30 lakhs in installments to the builder. The bank gives him both the above mentioned option of repayment to choose from.
1. Incase Raj opts for normal EMI route : In this case, from the date of the very first disbursement made to the builder, the bank will start charging full EMI in which Raj starts repaying a portion of the principal as well as interest. Hence, even though the entire loan amount has not been disbursed to builder, the bank charges EMI on the entire loan amount. Hence, for a loan of Rs.30 lakhs borrowed at an interest rate of 11% (and loan tenure of 20 years), Raj would have to start paying Rs.30,960/- right from the date of first disbursement.
2. Incase Raj opts for Pre-EMI route : In this case, the bank starts charging SIMPLE INTEREST only on the loan amount that has been disbursed to the builder, i.e. the monthly installment charged to Raj consists of only simple interest only on the amount released to builder. As bank goes on disbursing total loan amount in stages, the monthly installment payable by Raj starts as a very small amount in the beginning and gradually builds up over the construction period and at its peak, becomes equal to a normal EMI. Only after construction is complete and possession is given to borrower, does the bank start charging full EMI in which Raj has to pay both interest and portion of the principal.
Hence in this case, the Pre-EMI in the beginning could be as low as Rs.3000 (assuming 10% of loan i.e. Rs.3 lakhs is disbursed to builder in the first installment) and this would gradually grow every month to reach approx Rs.30,000/- (i.e. full EMI amount) by the time construction is completed.
Why is Pre-EMI advantageous to the borrower ?
As is apparent in the above example, opting for Pre-EMI route is highly beneficial over the normal EMI route due to below reasons :
1. Pre-EMI payments are much smaller than normal EMI amounts and hence will cause less stress to the borrower as his monthly outgo is drastically reduced compared to a normal EMI.
2. The entire Pre-EMI payment consists of purely interest and hence for those who register the property post completion, this entire amount can be claimed for tax benefits (entire interest paid is allowed to be deduced from taxable income over 5 years post completion of the project). If borrower opts for normal EMI route, then this huge tax benefit is missed out.
3. For those who are purchasing property purely as an investment and intend to sell it off in the short-term, it makes better sense to opt for Pre-EMI route as in this case you pay only simple interest on amount utilized and not the principal (as you will anyway foreclose the loan and are not going to keep the property for self occupation).
4. Certain builders these days offer properties under FREE Pre-EMI scheme, where the builder offers to pay the entire Pre-EMI interest on the loan taken by you until property is completed and handed over. In such cases too, option for Pre-EMI is the best option as once you make your 20% dowpayment, you pay nothing else until project is completed and handed over (by which time prices would have appreciated and you end up making abnormally high returns on investment as you have put only 20% of project cost whereas appreciation is enjoyed on 100% of property value). Click here for one such offer available to G&C clients.
The next time you take a home loan for property still under construction, always opt for Pre-EMI scheme as it is drastically lighter on your pocket due to much smaller installments and gives you higher tax savings in the long run.
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By Jhashank Roy Chowdary (About the Author)G&C Global Consortium ™ Our Website | Our Facebook Page firstname.lastname@example.org O : +9180-41520808/09/10