Simple Interest Accumulated during moratorium

Simple Interest Accumulated during moratorium

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Experts opine that the best way to neutralise the higher interest burden arising out of the moratorium will be to pre-pay the loan. If possible, borrowers must use the bounce-back method to repay their loan

  • The Centre in its October 2 affidavit agreed to waive interest on interest on loans up to Rs 2 crore to all retail and MSME borrowers for the six-month moratorium period.
  • While the government has decided to take the ‘interest on interest’ burden upon itself, only loans of up to Rs 2 crore will be eligible. For other retail investors, the interest still remains a big concern.
  • It may be noted that when a borrower avails of a moratorium, they don’t repay the principal component of the EMI and thus we observe that the loan outstanding remains the same.
  • Since they also don’t pay the interest component, that gets added to the outstanding.
  • Thus, your loan repayment has both simple and compound interest. While the compound interest will be taken care of by the government, simple interest will have to be paid by the borrower.

Explanation

  1. For instance, let us say that a person has a  loan of say Rs 5 lakh at the start of the moratorium period
  2. The interest rate is 10 per cent while the repayment period is 5 years
  3. Accordingly, the EMI would be Rs 10,624, of which Rs 8,334 would be the principal and Rs 2,290 would be the interest

 

  • In this example, the outstanding at the end of the first month of the moratorium will be Rs 5,02,290.
  • In the second month, the EMI will be calculated not on Rs 5 lakh but on Rs 5,02,290.
  • The next month also, the principal will not be repaid. The interest component in the second month will then become higher than 2,290.
  • This process will repeat for the rest of the period.
  • Since simple interest will keep accumulating, your outstanding loan amount at the end of the moratorium will be higher than at the start as the interest itself is not being waived during the moratorium.
  • Only the interest on interest is being waived. People may not realize that the interest component is the bigger burden.

Conclusion

  • According to experts, the best way to neutralise the higher interest burden arising out of the moratorium will be to pre-pay the loan.
  • If possible, borrowers must use the bounce-back method meaning they should aim to pre-pay up to 120 per cent of EMIs which they have deferred within 12 months from September 2020.
  • This means, if someone has deferred, say, five EMIs, they should pre-pay six EMIs over and above their regular EMIs if possible as this erase the burden of the additional interest that they will otherwise have to pay.

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