Home Loan Interest Calculation - Daily Reducing Balance Method
Foreword: Home loans last so long that even minor differences can have a substantial impact. All the lending companies doesn't calculate the EMI using the same method. There are two methods for home loan interest calculation. So, two banks offering same interest rate may not offer you the same EMI, even though the tenure and loan amount are also the same.
How interest calculation is done?
There are two methods of calculation for home loans. They are monthly or daily rest (or reducing balance) methods.
Monthly method - Though the EMI is paid monthly, the adjustment towards interest and principal is made only at the end of the month. For example, even if EMI is paid on 5th of the month, it is adjusted to principal at the end of the month. Interest on reduced principal will be calculated from next month.
Daily method - The adjustment towards interest and principal is made at the end of the day. For example, if EMI is paid on 5th of the month, it is adjusted to principal at the end of the day. Interest on reduced principal will be calculated from next day.
The daily rest method is always cheapest.
There are two methods of calculation for home loans. They are monthly or daily rest (or reducing balance) methods.
Monthly method - Though the EMI is paid monthly, the adjustment towards interest and principal is made only at the end of the month. For example, even if EMI is paid on 5th of the month, it is adjusted to principal at the end of the month. Interest on reduced principal will be calculated from next month.
Daily method - The adjustment towards interest and principal is made at the end of the day. For example, if EMI is paid on 5th of the month, it is adjusted to principal at the end of the day. Interest on reduced principal will be calculated from next day.
The daily rest method is always cheapest.
How much difference does it make?
Let us calculate EMI for two cases, using both methods.
Let us calculate EMI for two cases, using both methods.
Case-1: Loan amount - 25 Lakh, Tenure - 20 years/240 months, Interest rate - 9.5%
| Method | EMI | Savings per month | Total savings | Savings as per RD* |
|---|---|---|---|---|
| Daily (SBI) | 22,955/- | 348/- | 83,520/- | 2,04,995/- |
| Monthly | 23,303/- | NA | NA | NA |
| * RD - Savings are invested monthly in Recurring Deposit with 8% interest rate for 20 years | ||||
Case-2: Loan amount - 35 Lakh, Tenure - 20 years/240 months, Interest rate - 9.5%
| Method | EMI | Savings per month | Total savings | Savings as per RD* |
|---|---|---|---|---|
| Daily (SBI) | 32,137/- | 488/- | 1,17,120/- | 2,87,465/- |
| Monthly | 32,625/- | NA | NA | NA |
| * RD - Savings are invested monthly in Recurring Deposit with 8% interest rate for 20 years | ||||
Conclusion: With just a change in the method, customer can save over Rs.2,00,000/- by the end of loan tenure. All private banks and most of the public sector banks, use monthly rest method. Only few public sector banks (like SBI, SBH and Bank of Baroda), use daily rest method. That is why, we preferred SBI over other banks to our customers for home loan.