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Taking a home loan? Take pre-EMI
When looking for a home, there are two major steps: zeroing in on a home and getting a loan. Let's say you have finalised the first and your new home is likely to get constructed in about two years time.
You have started approaching Home Finance Companies to finance the deal. Most will give you two options: Advanced Disbursement Facility or Pre-EMI.
The question is: Which one to opt for?
To answer that, let's take an example.
Cost of home: Rs 30 lakh (Rs 3 million)
Loan amount: Rs 27 lakh (Rs 2.7 million)
Date of completion: Two years from now
Home loan tenure: 20 years
Interest rate: 8.5% per annum
Equated Monthly Installment: Rs 23,431
For simplicity, we would assume the interest rate does not change. And, if it does, it will affect both the options equally.
Advance Disbursal Facility
The HFC would disburse the entire amount to the builder immediately. Your EMI would also start immediately. You would start paying Rs 23,431 to the HFC for 240 months, starting from the current month.
The entire amount is not paid to the builder immediately (as above). The sanctioned amount is disbursed to the builder as and when the stipulated work as per the agreement is completed. For example, the bank may state that when the third floor slab is placed, 25% of the amount will be disbursed. When sixth floor is complete, another 25% will be paid. This is known as partial disbursement.
During this time, before the entire loan is disbursed by the HFC to the builder, you will have to pay pre-EMI to the HFC. This pre-EMI is actually the interest on the amount disbursed (partial disbursements).
In our example, it will be the total amount disbursed over the construction period of two years.
Pre-EMI is the interest on the partial disbursals till the final disbursement is made. Once the final disbursement is made by the HFC to the builder, your EMI starts.
So, for first two years, you would be paying only interest and not repaying any principal; thereafter, you would be paying your EMI for 240 months.
Which one is costlier?
On the face of it, most of you would tend to feel the pre-EMI option is costlier. After all, you are paying interest for two years plus EMI for 240 months.
In the ADF option, you are just paying 240 EMIs.
What's more, if the construction period gets delayed by say six months, you will again have to pay interest for these months in addition to the two years.
No such issues under ADF, where delay in construction won't hit you.
But it's not as simple as it looks. Take a closer look at the figures before you jump to a conclusion.
ADF is good, in fact very good. But not for you! It's good for the builder. The reason is that the sum you were supposed to pay him over a period of two years is paid to him on day one. He uses that money and you pay interest on it.
1 to 24
25 to 240
241 to 264
* See How pre-EMI was calculated to understand how we arrived at this figure.
Under ADF you're paying Rs 13,470 (23,431 - 9,961) extra for each of the first 24 months. However, you will have to pay an extra Rs 23,431 under pre-EMI for each of the last 24 months (month starting from 241 till 264).
Now if the amount of Rs 3,23,280 (13,470 X 24) saved in the beginning is invested for almost 20 years at an average rate of 10%, the amount would almost be Rs 21,75,000.
The amount required for repayment is 23,431 X 24 = Rs 5,62,344.
So, under pre-EMI, you would gain by over Rs 16,00,000 at the end of 20 years. If the construction gets delayed then the gain would be even more.
The builders know it
That is why, off late, they have started offering carrots to the buyers. So if you agree to go for ADF, some builders would offer you a discount in property cost while others would even be ready to reimburse your pre-EMI interest burden. Some might even offer a combination of both!
Would it then make sense to go for ADF?
We still hold to our contention: ADF results in you financing the builder.
Is it right for you to do so? We think not.
Your concern with the builder should only be for buying the property. Where financing is concerned, let specialised agencies such as banks do it. Let there be pressure on him to complete the construction to get his full dues.
When you took a home loan, did you opt for the ADF or pre-EMI? What was your reason? Did the builder complete his work on time? If you are taking a loan, what would you prefer? Let us know.
ADROIT is a Pune-based firm that specialises in providing domestic and international tax services to salaried individuals and professionals.
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