How to Calculate Interest Rate on Home Loan?

When you avail a home loan, you borrow an amount or principal and repay it with interest. What is the interest rate on a home loan? It is the amount you are charged for borrowing from a lender, expressed as a fraction of the principal. Therefore, how much interest on home loan is to be paid by you directly depends on this value.

An interest rate change of even 0.5% can make a huge difference to your EMIs because home loan amounts are large. So, knowing how to calculate home loan interest rate is important as is learning how to reduce home loan interest rate to make repayment more affordable.

Below is a short guide on how home loan interest is calculated in India.

How to Calculate Home Loan Interest Rate?

You cannot compute the home loan interest rate yourself, but you can be informed about the factors that affect the interest rate. These are 3 factors that determine the home loan interest rate offered to you.

• RBI policy: Currently, the RBI requires all banks to link their home loan interest rates to an external benchmark, such as the repo rate. So, what banks offer borrowers is, for instance, the repo rate with a spread. Housing Finance Companies and NBFCs also base their home loan interest rate on the prime lending rate (PLR), which is also determined by the repo rate. Bajaj Housing Finance Limited offers repo rate linked interest rates to customers as per internal underwriting policy.
• Internal policy: When financial institutions have ample money to lend, as was the case after demonetisation, they can offer low home loan interest rates. The opposite happens when there is shortage of funds in the economy. Likewise, when the demand of loans is high, the interest rate charged may be high.
• Credit score: Borrowers who have a high credit score are deemed creditworthy and benefit from the lowest home loan interest rates. A low credit score means high risk and so, the interest rate charged would be higher as a compensation.

How to Calculate Home Loan Interest?

You can know how much interest on a home loan is charged to you by calculating the total cost of the loan and subtracting the principal from that.

The total cost of the loan (principal + interest) is governed by the formula,

Total loan cost = P x R x N/ (1-(1+R)^-N)

Where,

            P = Principal or loan amount

            R = Monthly interest rate in decimal form

            N = Number of months

You can calculate home loan interest in two ways:

• Manually
• Online

1. Manual Calculation

Assume a home loan of Rs.20 lakh taken for 20 years at a 10% rate.

Here,

P = 20,00,000

R = (10/12)%

N = 240

Hence,

            Total loan cost           = (20,00,000 x 0.0833 x 240)/ (1-(1+0.0833)^-240)

                                     = ~Rs.46,30,832

Therefore,

            Interest = Total loan cost - Principal

                        = Rs.46,30,832 - Rs.20,00,000

                        = ~Rs.26,30,832

2. Online Method

You can use the home loan EMI calculator to compute your interest, as it offers not just the EMI value, but the total interest and total amount payable as well. To use it, fix a value for the loan amount, set the tenor, and know what the current interest rate is.

Enter these values into the calculator or use the slider to obtain results such as:

How to Calculate Interest On Loan Per Month?

To know how much interest you are paying per month, refer to the home loan amortization schedule or use an amortization calculator. In brief, while the EMI amount you pay remains the same every month, the amount of principal and interest per EMI changes along the tenor. At the start of your repayment, the EMI comprises mainly the interest and towards the end, you paying more of the principal.

How to Reduce Interest Rate on Home Loan

Once you know what is the loan interest rate range offered by your lender, take steps to secure the lowest rate. Here are some tips:

• Boost your credit score: Creditworthy individuals get lower rates
• Ask for a smaller loan: This reduces risk as your debt to income ratio drops
• Pay over a long tenor: This reduces the chances of an EMI default
• Apply jointly: The risk to the lender is less by spreading the repayment responsibility among two borrowers

With this information, not only will you know how to calculate your home loan interest, but you will be able to understand the factors that affect the home loan interest rate. So, Make sure you prepare beforehand and fill the Home Loan Application form to enjoy quick approval.