Reducing Balance Mehod for Home Loan Calculation Explained - Home Loan Blog - Tata Capital

How to Calucate your Home Loan Interest Using Reducing Balance Method

Mar 10, 2017

When you take a home loan, you are mostly bothered about things like how much loan you will get, what interest rate is being charged, how long will be the tenure, etc.

But most people don't know how lenders actually calculate the interest on your outstanding loan amount every month? You might ask as to why is it necessary. It is because it will tell you how loans work and then, no one will be able to take you for a ride when it comes to loans.

So let's see how interest is calculated for home loans.

Generally, lenders use 'reducing balance' method to calculate interest on home loans.

Suppose you take a home loan of Rs 50 lac for 20 years at 9% rate of interest. Each month, you will be paying an EMI of Rs 44,986. As you might already know, each EMI goes towards repaying the principal as well as interest component.

Now in first month, 9% will be charged on the full Rs 50 lac. This means that out of the EMI of Rs 44,986, the first month's interest i.e. Rs 37,500 will go towards interest payment and remaining Rs 7486 will go towards repayment of the principal.

At the end of the first month, you are left with a balance outstanding principal of Rs 49, 92,514 (Rs 50 lac - Rs 7486).

Now in second month, 9% will be charged on a reduced balance of Rs 49, 92,514. So the interest amount of the EMI is now Rs 37,444. The balance amount of Rs 7542 (which is slightly more than previous month's Rs 7486) goes towards principal repayment. And this continues month after month, till the loan is paid off completely.

So that is how the reducing balance method is used for interest calculation. Now you know one very important aspect of home loans.