Simple interest accumulated during moratorium remains the bigger concern

The government has announced it will take upon itself the burden of ‘interest on interest’ incurred by borrowers during the moratorium period. Loans of up to Rs 2 crore will be eligible.

Suppose you had a loan of Rs 1 lakh at the start of the moratorium period. The interest rate is 10 per cent and repayment period is 5 years. Your EMI is Rs 2,027, of which Rs 1,361 is the principal component and Rs 667 the interest. 

“When you avail of a moratorium, you don’t repay the principal component of the EMI, so the loan outstanding remains the same. And you also don’t pay the interest component, so that gets added to the outstanding,” says Aditya Mishra, founder and CEO of SwitchMe, a digital home loan broker. 

In this example, the outstanding at the end of the first month of the moratorium will be Rs 1,00,667. In the second month, the EMI will be calculated not on Rs 1 lakh but on Rs 1,00,667. Again, the principal will not be repaid. The interest component in the second month will be higher than Rs 667. This process will repeat for the rest of the period.

Another way to see this is that your loan will have simple and compound interest. The difference — what ‘interest on interest’ amounts to — is what the government will pay.

Since simple interest keeps accumulating, your outstanding at the end of the moratorium will be higher than at the start. “Remember that the interest itself is not being waived. Only the interest on interest is being waived. And the interest component is the bigger burden,” says Mishra.  

Do not do anything for the present. Once the Supreme Court pronounces its decision, the government will, in all likelihood, provide further details of the relief. You will then have to see how your bank operationalises all of this.

Borrowers who wish to restructure their loans should be careful. 

“Read the fine print of the restructured loan agreement because each bank will have its own policy. Watch out for any hidden charges,” says Raj Khosla, founder and managing director of MyMoneyMantra.

The best way to neutralise the higher interest burden to arise because of the moratorium will be to pre-pay the loan. “Use the bounce-back method, that is, aim to pre-pay up to 120 per cent of EMIs you had deferred within 12 months from September 2020. If you had deferred five EMIs, pre-pay six EMIs over and above your regular EMIs. This will erase the burden of the additional interest you will otherwise have to pay,” says Adhil Shetty, CEO, BankBazaar.