Loan Repayment

Introduction

Loans are a great way of keeping the economy afloat. Individuals and entities depend on bank loans to a great extent in running many aspects of their lives and businesses. Banks and Non-Banking Financial Corporations (NBFCs) in India offer loans for varied purposes. The loan business in banks are categorized into personal segments, business loans, SME loans & corporate loans.

Loans can be taken for specific purposes, like home loans, vehicle loans, educational loans, or for unspecified purposes like personal loans, gold loans, business loans, etc. Loan amounts also differ broadly based on the loan product.

Until September 2020, the banks in India have disbursed an overall cumulative credit of Rs.1.13 lakh crores in the MSME sector alone. Home loan disbursement stood at around Rs.1.02 lakh crores for 2020.

With the CoronaVirus pandemic, the economy needed a huge boost and it came in the form of low cost loans to all segments of consumers. SBI still tops the charts with one of the best interest rates across all loan products.

What is a Loan? Definition, Types & Advantages

A loan is an amount of money borrowed from banks or other financial organisations by one or more people or businesses to fund scheduled or unplanned activities. The consumer then takes a loan that he must repay within a given amount of time and with interest.

Loans serve as ultimate financial aids in times of need. One can get loans for almost anything; starting from personal loans, vehicle loans, home loans, education loans, to business loans, one can find a suitable product for all their needs. These days, banks and NBFCs are offering competitive loan products to attract consumers. Loans are processed and disbursed in as less as 48 hours to put the much needed funds in the consumers’ hands.

Before any money switches hands, the recipient and the lender must agree to the terms of their credit. In such situations, the lender demands that the borrower give a collateral asset which is defined in the loan contract.

Individuals, companies and governments can be granted loans. Getting funds to expand one's total money supply is the key theory behind taking them up. Interest and charges provide the lender with income.

Loan Categories: How are loans classified?

Loans are of these 2 basic categories; Secured and Unsecured & Open-End and Closed-End

1. Secured and Unsecured Loans: A secured loan is backed by some kind of collateral, security or guarantee. An example for a secured loan is home loan. Unsecured loans generally do not have any collateral or security. Personal loans are a good example of unsecured loans.

2. Open-ended and Close-ended: These are also known as Revolving Credit and Term Loans respectively. Revolving credits can be borrowed, repaid and utilized again. Whereas Term Loans are borrowed, repaid and closed down. An overdraft facility is a revolving credit, while personal loans are term loans.

What is loan repayment?

Loan repayment is how the borrower pays back the borrowed money to the lender. The loan amount is generally repaid in equated monthly instalments called the EMI, which is made up of the interest component and the principal component.

The EMI amount, along with the interest and principal breakup are given in a schedule called the Amortization Schedule. This table gives you the exact amount of interest and principal that is deducted from your loan amount with every EMI you pay. There are other types of loan/credit repayment options too.

Most Common Types of Loan Repayments

Loan repayments are generally done through monthly EMIs. Occasionally, there is the option for Bullet Repayments too. Repayments options are largely based on the type of loan, loan amount, interest rates, chosen tenure and the repayment capability of the borrower. Let’s have a look at the two most common types of repayments available for different types of loans;

EMIs – EMIs or Equated Monthly Instalments are the most common type of repayment option available for any type of loan. In this repayment type, the total sum of loan amount plus the total interest is divided into equal monthly instalments of the loan tenure. This amount is called the EMI, and is paid by the borrower on a fixed date every month. As the number of EMIs keep getting paid, the interest amount and the principal amount are reduced from the loan amount correspondingly, until the entire loan amount is repaid. The loan is then closed.

With EMI repayments, customers are able to manage their monthly finances better. They are able to plan ahead for other expenses too. Banks even allow ‘Part prepayments’ and ‘Full Pre-closures’ on your loans, that allow you to utilize any bulk amount you may come into, during the course of loan repayment.

EMIs are of different types like regular EMI, step-up EMI or step-down EMI. One must go through the features and benefits of all these methods before choosing the best repayment option to suit one’s needs.

Bullet Repayment - Some loan products would allow you to repay the loan via bullet credit repayment process. In this option, you need to pay just the interest portion per month. When the tenure of this loan expires, you have to repay the whole principal loan in one shot.

Bullet repayment is a lump sum payment made for the full loan value, usually at the end of the loan term. It may also be considered as a single debit balance on a loan. Bullet repayments are usually applied for gold loans and a few types of business loans.

Customers are allowed to make smaller, variable payments over the tenure of the loan, which will be adjusted against the interest component. The principal is always repaid at the end of the term as a single payment.

What is an EMI?

The Equated Monthly Instalment (EMI) is the amount of money that is paid back to the loan on a monthly basis. Essentially, it consists of two parts, the principal payment and the interest on the principal amount, split over each month in the lifetime of the loan. The EMI shall always be credited to the bank or loan on a set date per month before the cumulative amount due is paid within the term of the loan.

Interest and the principal component of the EMI amount are not equal. In the initial years the interest component repaid is higher and in the later years the principal component is higher. So, over a period of 5 to 10 years, you will definitely have greatly decreased the overall interest component owed and would only have repaid the interest component for the most part.

Different Types of EMIs for Credit Repayment

EMIs are of different types based on the repayment schedule, loan amount and the stage of the loan.

Regular EMI – This is the regular EMI that is paid on a fixed date every month. It is made up of interest and principal. It is usually paid every month until the end of the loan tenure or until the entire loan amount is paid up.

Pre-EMI – This is usually applied in Home Loans. Based on the construction stage of the property, you are required to pay interest only on the disbursed loan amount, and not on the entire loan amount. This is called Pre-EMI.

Step-Up EMI - In Step-Up EMI, the initial EMI paid is less and gradually increased over the tenure of the loan, under the basis that the estimated income of the creditor is also increased. Generally, the EMI adjustment may well have happened twice over the full length of the loan.

Step-Down EMI – In this EMI type, the EMI amount is gradually decreased based on the number of payments made and the outstanding loan amount.

Types of Interest Rates on Loans

Interest on loan is the charges you pay to the lender for servicing the loan. The interest is determined based on various factors, like the loan amount, your income, age, existing assets & liabilities, and many more. The monthly EMI consists of your interest component and the principal component.

Interest rates are basically of two types; Fixed Rate & Floating Rate

In Fixed Interest Loan, the rate of interest shall be determined on the full amount of the loan and the amount of interest shall remain the same for the entire term of the loan. Usually, this form of interest is extended to short-term lending, such as personal loans. Because the amount of interest remains the same over the lifetime of the loan, this form of loan would turn out to be costlier than the floating rate of interest.

Whereas, in a Floating Rate of interest loan, the interest rate changes many times over the tenure of the loan. The interest rate is based on the MCLR rate fixed by the bank and changes based on the lending rates announced by the RBI regularly. Though the interest rate fluctuates on a regular basis, there is no change in the EMI amount. The interest component of the EMI amount changes accordingly and so does the principal amount adjusted against your total outstanding.

What is Reducing/Diminishing Rate of Interest?

Reducing/Diminishing Rate of Interest is a common way of interest calculation on loans. When you pay the EMI, some of the amount goes towards the interest payment for the month and the balance goes towards the payment of the principal sum. As a result, the principal balance is decreased in the next month and the interest amount is therefore lowered as it is based on the reduced principal amount. So, any amount you pay extra, will be adjusted towards the principal part and the interest component on your consecutive EMIs keeps decreasing.

Loan Repayment Options Available for Home Loans

Home Loans is one of the most sought out loan products in India. Owning a home is considered an important milestone in one’s life and home loans come in handy to help you realize that dream. Home Loan products have evolved over the years to give attractive benefits and offers to the applicants. Banks usually offer the follow repayment options on home loans:

Regular/Fixed EMI Repayment: This is a common and simple form of EMI payment. The customers are given a fixed EMI amount to pay every month over the tenure of loan. This EMI amount consists of the interest component and the principal component. Customers are given additional benefits like prepayment, part payment, overdraft facilities and many more. These EMIs are sometimes calculated in fixed interest rates but mostly in floating interest rates for home loans.

EMI Moratorium: Customers who would like to have some breathing space before they start paying the EMIs, can opt for a moratorium period on the EMI payments. Moratorium period of up to 5 years can be availed, where the customer only makes a nominal payment towards the interest component of the loan. Upon completion of the moratorium period, the regular EMIs shall commence.

Step-Down Credit Repayment Plan: In this EMI type, the EMI amount is gradually decreased based on the number of payments made and the outstanding loan amount. The Step-down Repayment System is also known as the Adjustable Rate Plan. This arrangement is formulated in such a manner as to reduce the EMI balance owed on your home loan as the loan progresses. This means that the debt payments, i.e. the EMIs, will be higher in the early years and will be diminished in the years to come. This plan incorporates the idea of the reduction of the balance to calculate the sums of the EMI at various points of the repayment.

Step-up Repayment Plan: In Step-Up EMI, the initial EMI paid is less and gradually increased over the tenure of the loan, under the basis that the estimated income of the creditor is also increased. Step up repayment schedule is formulated in such a manner that the EMI for your home loan starts to increase in the first three years. This means that the EMI will be smaller in the initial years and will rise for a certain amount of time. ⠀

In this form of lending, a larger loan balance can be used and lower EMIs can be paid in the initial years. The repayment is, however, accelerated with the progression of loan period. This repayment strategy is ideal for those who are sure of higher wages in certain years or in the immediate future.

Pre-EMI: This EMI method is used for under construction properties. The loan amount is released in tranches based on the level of completion of the property. So, the borrower needs to pay interest only on the disbursed amount. So, the EMIs are less in initial years as the disbursed amount is also lower. As the loan amount keeps getting disbursed, the corresponding EMI shall also increase.

Loan Repayment Options Available for Personal Loans

Personal loans are fixed term loans. The EMI amount is generally fixed over the term of the loan. However, interest calculation can be flat or diminishing, based on the product. Customers should check with the bank to ensure that the best interest calculation method is used for their loan.

Personal loans are usually repaid via monthly EMIs. The EMIs can be paid via post-dated cheques (“PDC method”) / the Electronic Clearing System (ECS) / direct debit from the Borrower’s bank account held with the lending bank (“Direct Debit method”) / by deduction from the Borrower’s salary account (“Salary Debit method”) / by directly paying amounts when due to the Lender (“Direct Payment method”).

The method of credit repayment is usually chosen at the time of loan disbursement, however, this method can be changed at a later date by submitting the relevant forms to the bank branch.

Personal loans are generally applied at a fixed rate of interest, and hence, the EMI amount remains the same throughout the tenure of the loan. Banks do allow prepayment or pre-closure of personal loans. Most banks do not allow part-prepayment for personal loans.

Loan Repayment Options Available for Educational Loans

Educational loans come with many attractive repayment options.

The moratorium period on educational loans is usually till after 1 year of course completion or 6 months after securing a job, whichever is earlier.

Once the moratorium period is over, repayments are done via monthly EMIs.

Educational loans allow you to make regular or lump sum payments during the moratorium period, which shall be adjusted towards the interest amount.

Educational loans can be pre-closed at any time during the loan tenure for no additional costs.

Credit repayment tenure of the loan can be extended if the course period is increased by the university

Loan Repayment Options Available for Car Loans

Car loans come with floating rates of interest. They usually don’t have a moratorium period; hence the EMI payments commence immediately.

Car Loan repayments offer the following options: 

Regular EMI – This is the regular EMI that is paid on a fixed date every month. It is made up of interest and principal. It is usually paid every month until the end of the loan tenure or until the entire loan amount is paid up.

Step-Up EMI - In Step-Up EMI, the initial EMI paid is less and gradually increased over the tenure of the loan, under the basis that the estimated income of the creditor is also increased. Generally, the EMI adjustment may well have happened twice over the full length of the loan.

Step-Down EMI – In this EMI type, the EMI amount is gradually decreased based on the number of payments made and the outstanding loan amount.

Balloon EMI / Bullet Repayment - In this process, borrowers are required to make lump-sum payments at the end of the repayment term. The balloon approach eliminates the initial pressure on the borrower of the loan.

Loan Repayment Options Available for Gold Loans

Gold loans are usually instant loans. Most banks offer Bullet Repayment on Gold Loans.

For Bullet Repayments, you are required to pay the interest as well as the principal amount at the end of the loan tenure, as a single payment.

You are allowed to make regular payments into the loan account during the tenure of the loan, but it is not mandatory. These payments shall be adjusted against the interest component of the loan.

Bullet repayments reduce the burden of monthly payments towards loan payments.

They are generally beneficial for business loans.

Loan Repayment FAQs