Home loan & EMI
These days, many young people are buying a house or an apartment of their own (and it makes perfect sense – please read “Settle early in life – buy a home when young” for an in-depth analysis). Most of them also take a housing loan (Also called a home loan, or a mortgage) to fund this costly acquisition.
But a home loan doesn’t just provide you the finance needed for buying your house. It also results in income tax saving year after year, for the entire tenure of the loan! To understand the income tax benefit of a home loan better, let’s first understand the Equated Monthly Installment, or the EMI.
Equated Monthly Installment (EMI)
When your home loan is sanctioned and disbursed, you receive a cheque for the entire loan amount (This cheque is in the name of the seller of the house, or the builder if you are buying the property directly from the builder).
This home loan is repaid in equal monthly amounts, which are called Equated Monthly Installments or EMIs. The EMI consists of two portions – the principal amount, and the interest for the home loan.
Through the principal portion of the EMI, you repay the loan in small bits every month. Thus, the outstanding loan amount (or the remaining loan amount) reduces every month by this amount.
Through the interest portion of the EMI, you pay the bank the interest on the outstanding loan amount.
Thus, when the loan starts, the interest component is very large, and the principal component is very small. Every month, the interest component becomes smaller than the previous month, and the principal component becomes larger than the previous month.
Over time, the principal component becomes larger than the interest component, and towards the end of the tenure of the home loan, the interest component becomes negligible.