How to Calculate Home Loan Interest Rate and How Does it Work?

When you avail a Home Loan, the lending institution charges an interest in return for financing your property purchase. You can think of the interest rate as the cost of borrowing the loan. You must pay this interest over the loan tenure in addition to the principal amount you borrowed. The total interest you must pay throughout the tenure is a crucial factor to consider when applying for a loan, as it significantly affects your loan cost. 
The following sections will discuss the Home Loan interest calculation method and how it works.

Types of Home Loan Interest 

Financial institutions offer two types of interest rates on Home Loans: fixed and floating. In a fixed-rate loan, the interest rate remains unchanged throughout the tenure. On the other hand, in a floating-rate loan, the interest rate fluctuates frequently according to the benchmark during the tenure.

Methods to Calculate Home Loan Interest Rate

Let’s look at the different methods for Home Loan interest calculation.

Calculating Simple Interest on a Loan

Calculating the simple interest is easier. You just need basic loan-related information, such as the loan amount, interest rate, and loan tenure, to calculate the overall loan cost. Although it has a fixed monthly payment, the interest payable each month depends on the outstanding loan balance. Therefore, if you pay it off early, you can save a significant amount on interest. 

Use this formula to calculate Home Loan simple interest: Principal Loan Amount x Interest Rate x Loan Term.

For instance, if you borrow a 15-year Home Loan for Rs 10 Lakh at an interest rate of 6%, the total simple interest will be Rs 9 Lakh, and your total loan amount will be Rs 19 Lakh. 

If you are not good at crunching numbers, use an online calculator to do the calculations instantly without any manual intervention.

Calculating Amortising Interest on a Loan

Many lending institutions follow an amortisation schedule for Home Loan interest calculation. These loans also have fixed monthly payments, but the interest changes over time. With such loans, the initial payments have a higher interest component, and the principal component increases as the tenure progresses. Here’s how to calculate an amortised loan interest:

• Divide the interest rate by the number of payments in a year.
• Multiply the result by the remaining loan balance to calculate that month’s interest payable.
• Subtract the interest from the fixed monthly EMI to calculate the monthly principal component.

Factors Affecting Home Loan Interest Calculation

Several factors affect your Home Loan interest calculation, including the following:

• Principal Amount: The principal amount you borrow largely affects your interest rate. The more you borrow, the higher interest rate lenders charge to take the risk. 
• Credit Score: Your credit rating is crucial to your Home Loan interest calculation. A decent credit score means a reasonable interest rate, as the lender will consider you a low-risk borrower.
• Repayment Tenure: The duration you take to repay the loan significantly impacts your interest calculation. The longer tenure you choose, the higher your chances of missing

EMIs and defaulting on the loan due to changing financial circumstances. Therefore, the lender tries to compensate for the loss by charging a higher interest rate.

Tips to Get the Best Home Loan Interest Rates

Follow these tips to boost your chances of getting a Home Loan at the most favourable interest rates:

• Maintain a high credit score to get competitive interest rates on your Home Loan.
• Opt for the shortest possible loan term with budget-friendly EMIs using a Home Loan EMI Calculator – a free-to-use online tool on the websites of financial institutions like Kotak Mahindra Bank.
• Minimise your DTI ratio to showcase a sufficient EMI repayment capacity without stressing your finances.
• Compare loan offers to find one with the lowest interest rates and most favourable terms and conditions. 

Before avail a Home Loan, calculating the interest rate is vital to understand the actual borrowing cost. Enquire whether the loan provider offers a fixed or a floating interest loan and whether they use a simple or amortisation formula for Home Loan interest calculation. You may also use an online calculator to make an informed borrowing decision. Furthermore, be mindful of the factors affecting your Home Loan interest rate, such as your credit score, DTI ratio, repayment tenure, principal amount, etc. The tips mentioned here will help you get the best loan deal at the lowest interest rate.

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