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Inside: The Rest Period in A Loan

 

 

 

To understand how a home loan works one needs to understand what a rest means. A rest is the interval at which the remainder of the loan amount is recalculated as you repay the loan. This is relevant only in the case of a reducing balance loan as opposed to a flat rate interest loan. These regular intervals or Rests can be yearly, monthly or even daily.

Financial institutions have various parameters surrounding the loan amount detailing the manner in which the loan is repaid. A “Rest” is nothing but the regular interval at which the loan amount balance is recalculated and also refers to the periodicity of compounding. This can be possible only in the case of reducing balance loan amounts.
These regular intervals or Rests can be yearly, monthly or even daily.

A yearly rest or an annual rest would mean that even when you pay EMIs on a monthly basis on your loan, the loan amount based on which you pay the interest, will be recalculated only at the end of the year(12 months). This means you would continue to pay interest on the entire loan amount , even when the outstanding loan amount reduces each month.

In the case of a monthly rest, the balance loan amount is recalculated and decreases every month. Hence it is to the advantage of the loan consumer to take up rest that more closely matches the frequency of his loan repayment. So if you are repaying your loan amount on a monthly basis, take up the option of a monthly rest. Banks generally charge an “annualized” interest rate, which is converted accordingly to a monthly rest or daily rest.

Here is a simple illustration that shows you that the interest rate on a monthly rest is lesser than that of an annual rest. Take two instances, where you borrow Rs. 20 lakh at a 10% annualized interest rate (which is obtained by multiplying the rate per rest period into the number of rests per year), where in one case the rate has annual rests and in the other case it has monthly rests.

Annualized interest

rate

10%

Loan tenure in

months

240

Loan amount

Rs. 10,00,000

Type of Interest

Rate

Annual Rest

Monthly Rest

Number of

compounding

periods

20

240

Interest rate in

each compounding

period

10.00%

0.83%

EMI

Rs. 9,788

Rs. 9,650

Total interest paid

Rs.13.5 L

Rs.13.2 L

To compare loan offers from multiple banks, you need to calculate the total amount of interest you would pay for each offer. Knowing the annualized rate quoted by each bank will help you calculate the interest rate you pay at different rest periods and enable you to compare offers even if their interest rates are quoted differently.

Source: Bank Bazzaar

By vayaM CS