How EMI is calculated!!

I decided to purchase a house in Banaglore (an extremely tough task) and the first thing that struck me is equated monthly installment or EMI. This is the single most important parameter while taking any kind of loan. This is the amount outgo every month from your personal finances which will cover both the principle as well as interest.

I talked to few people and everyone is bit confused on how EMI is calculated. It is really simple and just few steps would enable you to calculate EMI at your end.

So here is a rather simply formula for calculating EMI.

You would wonder why EMI is called "equated", the reason is that EMI is nothing but loan amount plus total interest divided by loan tenure. If that is the case then why this complicated formula. The reason is because as you keep paying EMI, some portion of EMI goes as interest but some portion goes as principal repayment. So if you pay an EMI of Rs10,000 for a house loan, not the entire Rs 10,000 would go as interest payment, but some portion goes as principal repayment, which essentially reduces the principal on which further interest is calculated. It is extremely important to understand what goes for interest and what goes for principal repayment.

It is very clear (for mathematically inclined) that when Loan Amount goes up, so does the EMI. Similarly if the interest goes up again so does the EMI, but if 'n' (loan tenure) goes up, EMI reduces. A note of caution, a low EMI for longer period does not necessary means a good bargain. A good bargain depends on your requirements as well as the total interest you pay over the entire loan tenure.

Another thing to keep in mind is whether the reduction in loan amount happens on monthly basis or yearly basis. Any loan which reduces the principal on monthly basis should be given preference. A monthly reduction implies less interest payment from next month onwards, definitely a huge savings.

Also usually interest rates comes in flavors of fixed and floating rates. A floating rate changes based on market's prime lending rate (PLR). A fixed rate stays fixed for the tenure of the loan. For a longer period of loan, my personal preference is always fixed interest rate, even if it is 1-2% higher, at least the monthly outgo is fixed, so planning of your outflows can be planned pretty well. I personally think that similar to rupee averaging for mutual funds, the floating rate almost remains same as fixed rate over a long tenure of loan. [The floating rate will go up and down and hence your monthly outgo]. And for short tenure loan, in a high interest regime, go for floating rate, but in a low interest regime choose fixed rate.

How to become Wealthy?

One of the best articles (by Clayton Cramer) I have ever came across. Go ahead read it and learn !!

Online Tax Filing

I recently stumbled upon the website of NSDL (National Securities Depositary Ltd) and got surprised to see the e-payment of taxes.



So clicked the link and found that anyone can pay the taxes online if they have netbanking facility with the mentioned banks.

If you are a salaried employee and have any outstanding tax to be payed, then instead of visiting a nearby bank branch you can directly submit the tax on-line using netbanking.

Dont confuse this tax-filing with return-filing (usually this is a common confusion). This facility is just to submit any extra tax (after TDS) that you are entitled to pay the government. This situation usually occurs (for salaried employee) if he has shifted job within a financial year and has not accounted for previous employer income to the finance department. So when you file the tax return you just need to provide a Challan Identification Number (CIN) obtained while paying the tax online. Pretty neat !!

It is definitely a welcome move from the income tax department.

Mutual Fund Offer Document

"Mutual fund investments are subject to market risks, please read the offer document carefully before investing"

How many times you have heard this or read this in all mutual fund advertisements? Well due to SEBI regulation every mutual fund will flash this warning. I personally think that mutual fund advertisements require a person who can talk at a speed of zillion words per minute before they recruit the guy to read the above statement.

Does anyone really read the offer document? SEBI mandates that as a customer you should read the offer document carefully.

What is an Offer document?

It is a prospectus that details the investment objectives and strategies of a particular fund or group of funds, as well as the finer points of the fund's past performance, managers and financial information. But since it is such a huge document, people rarely read it in entirety.

Key Information Memorandum

So to overcome this distributors usually come up with a KIM. It is shorter than an offer document and provides precious details about the mutual fund. So when you get a KIM, what you should look for as an investor:

Investment Objective

Investment objective will tell you the fund's goal and rationale. This must align with your personal goal and risk profile. For example, you might be looking at a fund which will at the least protect your capital, so reading the investment objective will tell whether a particular fund ensures that.

Asset Allocation

What this essentially gives is the percentage of your funds invested in equity or debts.

Minimum Investment

What is the minimum investment a fund requires. You might be looking at a SIP of Rs100 per month but that might not be available with the particular fund.

Past Performance Data

Although every mutual fund house will keep the warning "PastPerformance is not an indicator of future returns" but that is usually not true. A fund's past performance is a key factor in deciding how a fund will perform. I personally think that everyone should stay away from NFO, since they dont have any past performance.

Every investors must read the historical performance of the fund, and he should be looking at both the long and short-term performance. A fund's performance over a period of time should match with their own investment goals. They must compare the fund performance against that of the benchmark chosen by the fund.

Entry and Exit Loads

This is another most important information, since heavy entry and exit load will eat up into your investment growth. There are also other charges like switching charges or recurring charges or management fees. Over a period of time they can be considerable amount, so be aware of them.

Hope all investors be more aware of the pitfalls of this fantastic investment scheme.

Car dealer tricks

Let me ask you one question, if you have to choose between the following loans for the car which one would you choose:

a) The dealer has a tie-up with various banks who provide you loan at the prevailing rate of 13% for five years and 13.5% for three years. Although it is a huge interest rate (on a reducing interest basis) but its the same across all the dealers of the city. Most banks asks you for a margin amount as a downpayment (something like 10 - 15% of the cost value of the car). The dealer provides you a discount of 10,000 Rs on a particular car model.

OR

b) The dealer has a specific tie-up with a government bank which provides you the same loan amount at 7.75% interest rate for three years. This is almost half of the interest rate in option (a). The dealer does not offer you the discount mentioned in option (a) and all other terms remains same.

Which one you would opt?

Well this is the true fact that came to light when I proceeded with buying a car in the city of Bangalore. I went to the Maruthi showroom (Sagar Motors @ Bannerghatta Road) and inquired about a particular car model. I was told the on-road cost as X Rs. I told them that I want to take up a loan of just Rs 1.4 lakhs and the remaining amount will be as a down-payment in cash (which was way higher than the 10% margin required by most banks). Surprisingly even with so large a cash down-payment there was no special discount. I was told about the exorbitantly high interest rates charged by banks (13% -14%). I went home and talked to few other dealers and everyone came up with the same figures with no additional benefit.

Then one day we got a call from a dealer who said there is a special scheme with UTI bank which will provide loan on an interest of 7.75% for three years. I was ecstatic but was little curious that how could a bank provide me with such a low interest rate when all other banks are charging such higher rates. I asked the details and sure they were providing the loan at aforementioned interest rates, just that the dealer mentioned that he wont give the 10,000 Rs discount for this scheme.

Always do your own EMI calculation

So I got suspicious and decided to calculate the EMI. For a loan of 1.4 L for three years at 7.75% rate of interest the EMI comes out to be Rs 4340, while for a loan of 1.3 L for three years at 13.5%, the EMI comes out to be Rs 4360. In essence both the scheme are more of less the same (just a difference of 720Rs over three years period). It is just a gimmick used by the bank and the dealer to fool the customer with flashing a 7.75% rate of interest. I would suggest do your own calculation everytime.