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How your EMIs are affected by the govt waiver on levy of compound interest

A waiver on levy of compound interest, or interest on interest, on MSME and personal loans of up to Rs 2 crore may come as a major relief to borrowers, especially those whose loans are in initial years of repayment as their interest component is a major chunk. This would help in reducing the burden on borrowers as they require to pay on the contracted rate of interest on loans.

Since the moratorium on loan repayments announced by the Reserve Bank of India was not a waiver, borrowers are liable to pay interest and interest on interest on the accumulated amount. While the central government has announced that it will foot the bill for compound interest, customers still have to bear the liability of interest accumulated in during the six of the moratorium period. Sources said this waiver is expected to cost the government around Rs 6,000-7000 crore. This is how it may work:

What has to be paid?

The first thing that consumers must understand is the difference between interest and interest on interest. It must be clear that customers will have to pay the interest on their outstanding loan for the period for which they opted the moratorium.

So, if you had a loan outstanding of Rs 50 lakh for a remaining term of 19 years (228 months) at the beginning of the moratorium period and your interest rate was 8 per cent, the interest cost for the six-month period of the moratorium would come at close to Rs 2 lakh. This will have to be paid.

What gets waived?

Continuing with the above example, banks will not charge interest on this Rs 2 lakh interest amount from the customers and the government has proposed to pay it. So, the banks would not be adding the interest amount of Rs 2 lakh to your principal outstanding of Rs 50 lakh and will not calculate a fresh EMI at the prevailing interest rate.

So how will one pay the interest amount accumulated during moratorium period?

Since, the government has offered to pay the interest on interest component, banks and housing finance companies can simply divide the interest component — Rs 2 lakh in this case over 228 monthly instalments. Which means your EMI may get increased by Rs 877 per month.

How much do you save?

Continuing with the above example, if the bank had added the interest component to your principal outstanding and charged 8 per cent for 228 months, your EMI would have increased by Rs 1,709 per month. However, since now there is no interest to be charged on that (as the government has proposed to pay it), your EMI may only go up by Rs 877 per month. So a monthly saving of Rs 832 for the period of 228 months in this case (on account of waiver on interest on interest).

Source indianexpress.com
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