An equated monthly installment is also known as EMI and it is a combination of principal of the loan amount plus interest. All times depending on the loan type full loan amount will not be disbursed by the bank. In such cases, interest will be paid only for the disbursed loan amount which is also called as pre-EMI. The best example for pre-EMI is home loan. Suppose you have taken a home loan for under-construction property. Bank or lender will disburse loan amount in installments based on the stages of construction. In such cases full loan amount will be disbursed only at the end. Until full loan amount is disbursed, the borrower only has the obligation to pay interest for the disbursed loan amount. The actual EMI will start after the pre-EMI phase i.e. after construction of the home.
Let’s consider an example: Mr. A borrows ₹ 40 lakhs at the rate of interest of 10.5% with 20 years tenure for an under-construction property. The bank decides disburses loan amount in four stages.
|1-Jan||On agreement||₹ 10 lakhs (20%)||₹ 8,750|
|1-Jul||On completion of foundation and ground floor||₹ 10 lakhs (20%)||₹ 17,500|
|1-Oct||On completion of first and second floor||₹ 10 lakhs (20%)||₹ 26,250|
|31-Dec||On completion of third floor and possession||₹ 10 lakhs (20%)||₹ 39,935 (EMI)|
The borrower will end up paying pre-EMI (interest) amount of (8750 x 6) + (17500 x 3) + (26250 x 3) = ₹2,36,250 towards the disbursement of loan amount. And the EMI for remaining 20 years of the loan will start from 01 Feb.
Pre-EMI v/s Full EMI
Now that we know the difference between Pre-EMI and Full EMI, the question in mind will be which one to be considered while taking home loan. There is no right and wrong, both pre-EMI and Full-EMI are good way to repay the loan, however it depends on the borrower’s repayment capacity and ability to judge his financial commitments.
If the borrower is not financially very sound and if he/she is staying in a rented house, then the ideal option would be to choose pre-EMI loans. This will give the borrower the benefit of just paying interest on the loan disbursement which is affordable as compared to paying the Full-EMI. The borrower will thus be able to pay interest on EMI (pre-EMI) as well as rent on house until possession of a new house.
On the other hand, if the borrower of loan is a financial expert who has the ability to earn consistently great returns on small investments, then it is good to choose the option of Full-EMI. In this case, major portion of the EMI paid before construction will go towards the principal of loan amount, thus the home loan will get over quicker. By the time you take possession of the property, major portion of the loan will be cleared and the payment towards interest will be less.
The Benefits with Full EMI
The loan gets repaid faster. This happens because you pay both principal and interest at the same time. The EMI is as per the sanctioned amount and the interest calculated is only on the disbursed amount, and as a result, the outstanding principal goes down much faster.
The Benefits with Pre-EMI
It reduces your burden since you pay the interest only on the amount disbursed to you.
In case of full EMI, you need to pay more towards your home loan commitment before the possession. Whereas in the case of pre-EMI, what you need to pay is less than the full EMI.
Affording both house rent and Full EMI may not be an easy task for a middle-class family. But if you go with a Pre-EMI it becomes easier.
As the last disbursal is generally linked to possession of the house, you need to pay interest and rent till that time you get possession of the house. Once you get possession of your house, you can move into the house and stop paying rent. Hence, opting for a pre-EMI can be easy on your pocket and finances.
Whether you choose pre-EMI or full EMI, there is no change for tax deduction. Also tax deductions cannot be enjoyed by the borrower until the construction of the property is complete. Once construction is complete, interest paid on home loan before construction can be aggregated and deducted in five equal installments from the year during which the construction is completed. Tax deductions are not applicable for a principal amount paid as full EMI during the construction phase.
The buyer of housing property can claim interest on Pre-EMI as a deduction right after the construction of the property. It is quite often these days that everyone are booking house when it is still in under construction stage, the reason for this is to enjoy benefits of lower property rates. As more than 70% of India’s populations choose bank loan for purchasing a property, the relationship with bank begins as soon as the buyer signs contract with the builder to purchase the property. On the basis of this agreement, the builder’s reputation and financial stability, the buyer’s capacity to repay loan and CIBIL score, bank will either approve or reject loan for house.
If bank decides to sanction home loan, they then start partial disbursements of home loan amounts to builder as construction progresses. Once bank begins to disburse loan amounts in installments it will start to charge interest on the amount that is disbursed, this is Pre-EMI. Though you can generally claim interest deductions from income while filing tax, Pre-EMI interest is eligible for deductions only after construction of the house property gets completed. However Income Tax Act has provision which will help the buyer to claim deduction on the accumulated interest for pre-construction period in five equal installments from the year in which the construction is completed.
E.g. If Sarah books a under construction house in June 2014 and gets home loan approved for Rs. 20,00,000 from a bank. She has to pay interest of Rs. 2,00,000 until the year she gets possession of house i.e. May 2016, post this period she can claim entire sum of Rs. 2,00,000 interest from FY 2016-17 onwards in 5 installments, which will be 2,00,000/5 equals to Rs. 40,000 per year until FY 2020. These benefits can be enjoyed if it is a self-occupied house property post construction.
Factors to be Considered before Choosing Pre-EMI
With the option of pre-EMI the loan borrower will have less cash flow for at least the first 24-36 months. But in return the tenure of the loan will get extended with this type of option. Most of the cash flow will get accounted towards loan interest only and there will be no much difference on the principal amount. Careful consideration is demanded while taking pre-EMI loans, all aspects should be considered plus any amount that is saved now should be used for wise investment options. Here are some of the questions to be considered before choosing PRE-EMI:-
- How much money you have to repay loan?
- Will you be able to afford rent and EMI together?
- Is the property for own use or for rented purpose?
- If used for rented purpose, what is the expected rent?
- Is the property for using or for re-sale purpose after construction?
- What is the opportunity cost of money that you are looking to save?
- Is there any option to get better returns through other investment?
When to Consider Pre-EMI option?
Choosing pre-EMI over Full EMI is best when there is less fund to afford rent and EMI. It is also best during scenarios such as:-
1) If you have plans to sell the property within first few years.
2) If you have plans to sell the property right after construction.
3) Difference between Full-EMI and pre-EMI can be invested to enjoy higher returns.
4) If you want to save some cash for some other very urgent needs.
When to Consider Full-EMI?
This option is best in scenarios such as:
1) If you want to enjoy tax benefits right away.
2) If the property is just for long term investment.
3) If you would like to be debt-free soon.
4) If you expect delay in construction completion.
5) If there is no other better investment option for fund.
Basic formula for calculating Pre EMI is:
[P X r X (1+r) ^ n]/ [(1+r) ^ n-1]
r = Interest rate per month
P = Loan amount or principal
n = Number of total installments
Does Pre-EMI affect Home Loan Tenure?
Usually pre-EMIs do not affect loan tenure as it is considered post construction is complete on the home. However, if the builder delays the construction, then the buyer will end up paying more interest on the disbursed loan amount. Some builders will offer a proposal that they will pay the Pre-EMI until 2 years or 3 years. Be careful when you get into such contracts, if the construction is delayed beyond agreed period, then the rest of the pre-EMI has to be paid by the buyer of the property.
Instead another option is builders will agree to pay the Pre-EMI until completion of construction and handing the keys. This option is good from the buyer’s point of few. In case if the construction is delayed, the value of the property keeps appreciating plus the builder will bear the pre-EMI charges as long as construction gets extended. This will also pressurize the builder to complete the construction within agreed timeframe as he will not be willing to take additional expenses post agreed period of time.
Make use of this information if you are planning to pick a house under construction with home loan. Analyze which type of loan is best suiting your needs and accordingly make a decision whether to go with Pre-EMI or Full-EMI option. At the end of the day the available cash should be utilized for the best and greater return on investment. Have regular conversation with builders to understand the construction progress and what would be the expected completion of project. Do visit your property every now and then; whether it is taken through Full EMI or Pre-EMI, it is your property.
(Updated – 04-09-2018)