Home » News » Personal Finance»Home Loan
Mar 20, 2013, 12.47 PM | Source: Moneycontrol.com

Understanding how your home loan offer works

To understand how a home loan works one needs to understand what a rest means. A rest is the interval at which the remainder of the loan amount is recalculated as you repay the loan.


To understand how a home loan works one needs to understand what a rest means. A rest is the interval at which the remainder of the loan amount is recalculated as you repay the loan.

Financial institutions have various parameters surrounding the loan amount detailing the manner in which the loan is repaid. A “Rest” is nothing but the regular interval at which the loan amount balance is recalculated and also refers to the periodicity of compounding. This can be possible only in the case of reducing balance loan amounts.

These regular intervals or Rests can be yearly, monthly or even daily.

How to choose your home loan offer
For the twins Gayathri and Sanjana, fate intended that everything in their lives should happen in unison. Be it their first visit from the tooth fairy or their first job, the precision in timing was astounding. It so happened that they decided to buy their dream homes too around the same time.

The destiny that bound them together did not apparently bind their natures as Gayathri was very laid back and did not care too much for numbers, so she approached the first friendly bank who treated her like a queen, when she applied for a loan and took their best offer. Sanjana on the other hand did her research and had offers from several banks. Back at home Sanjana compared notes with Gayathri, who almost jumped for joy. She felt that she had landed an excellent loan bargain with minimum fuss, unlike her sister. After all, for the same loan amount of Rs. 20 L with a 20 yr loan tenure, Gayathri had an annualized interest rate of 12.75%, while the two loans that Sanjana had shortlisted from a bunch of loan offers, were both quoted at an annualized interest rate of 13% ! However, Gayathri’s joy was short lived, when Sanjana explained how appearances can prove to be deceptive!

The loan offer Gayathri obtained was a flat rate loan. Banks can calculate their interest rates either at a flat rate or a reducing balance rate. Sanjana on the other hand, had shortlisted two reducing balance loan offers with different rest periods. As her calculations revealed the loan offer with a monthly rest turned out to be a better loan bargain than the one with an annual rest. Let us examine these two aspects stated above in detail.

At a flat rate , the interest rates are calculated keeping the outstanding amount (i.e. the amount on which interest is calculated) constant throughout the loan tenure while in a reducing balance loan the interest rate is recalculated on a periodic basis based on the reducing outstanding loan amount.

Sanjana explained to Gayathri that at any given point in time, an X% flat rate is always more expensive than an X% annual reducing balance rate. Even in the case of a reducing balance loan a significant factor that impacts the loan cost is the time interval at which the reducing balance is recalculated, which could be monthly, daily, yearly, quarterly or half yearly. These time periods are known as rests, which denotes the regular interval at which the loan amount balance is recalculated and also refers to the periodicity of compounding. This can be possible only in the case of reducing balance loans.

The table below has the results of Sanjana’s calculations that helped Gayathri calculate the real cost of her loan.

Loan type  A B
Gayathri’s Flat Rate Loan Sanjana’s Reducing Balance Loan
Annualized interest rate for a Rs.20 L loan with a loan tenure of 20 yrs 12.75% 13.00%
Type of Rest Does not apply Annual Rest Monthly Rest
EMI  Rs. 29,583 Rs.23,726 Rs.23,432
Total interest paid 51 L 36.94 L 36.23 L



Flat rate loan vs. Reducing balance loan
In the above table, a comparison between Column A and B reveals the difference in the impact between a flat rate loan and a reducing balance loan.
It is clear that the effective interest that Gayathri will need to pay up with her current loan offer is much higher amounting to 51 L while the loan offers Sanjana had zeroed in on for the same loan amount and tenure was much lower showing a difference of nearly Rs. 20 L in the interest paid out!

Choosing the offer with the ideal ‘rest’
To make the most of your reducing balance loan you need to ensure the periodicity of repayment closely matches the frequency of your rest.

Sanjana was quick to realize this and her calculations revealed that a yearly rest or an annual rest would mean that even when you pay EMIs on a monthly basis on your loan, the loan amount based on which you pay the interest, will be recalculated only at the end of the year (12 months). This means you would continue to pay interest on the entire loan amount till that particular year (compounding period, when the outstanding loan amount is recalculated) ends, even when the outstanding loan amount reduces each month.

In the case of a monthly rest, the balance loan amount is recalculated and decreases every month. Hence it is to the advantage of Sanjana to take up a loan offer with the rest that more closely matches the frequency of her loan repayment. So if you are repaying your loan amount on a monthly basis, take up the loan offer that gives you the best rate on a monthly rest.

Banks generally quote an “annualized” interest rate, but remember that interest rates can be deceptive unless you figure out how they are defined. You can easily calculate the total amount of interest that you will pay for each offer by multiplying your EMI into the number of monthly installments and subtracting the loan amount from this figure. You can then easily identify which loan is the most cost effective for you. Remember to account for any upfront fees (e.g. processing fee) while comparing two loans.

What about daily reducing balance, you may wonder! Well, it makes sense to opt for a daily reducing balance only if you receive your income at different points of time during a month and can repay your loan at several or different points of time during a month. While this may not make sense for a salaried individual unless he or she has several sources of passive income, it becomes very relevant to self-employed people or individuals in a business that will have incoming funds at irregular intervals. For e.g. LIC has plans to launch a specific loan scheme for self-employed individuals where they can opt to pay daily or even quarterly payments.

In summary, the key to understanding your loan offers from multiple banks is to calculate the total amount of interest and fees you would pay for each offer and zero in on the offer that gives you the least total interest outflow.


BankBazaar.com is an online marketplace where you can instantly get the lowest loan rates , compare and apply online for your personal loan , home loan , car loan and credit card from India's leading banks and NBFCs.


Ask the Experts

Get your Personal Finance queries answered

  • Q

    i have been investing in the follwoing MF for the past one year should i contiune or switch to other funds. 1 Axis equity fund direct(g) 2 Axis gold fung direct (g) 3 Birla Sun Life Dynamic Bond Fund - Retail Plan dirct (g) 4HDFC Mid-Cap Opportunities Fund (G) 5 ICICI Prudential Dynamic Plan - Direct Plan (G) 6 ICICI Prudential Top 200 Fund (G) advice if i have to switch, all are for long term


    All the schemes look fine and you may continue. The amount that you invest in respective schemes is not known, so just make sure you have al...

  • Q

    i want to investment in 60 lacs invest in mutual fund and i accept 16 percentage return per year my goal after 10 years 2.80crs what is possible please true guide


    Equities over a long term are expected to give a return of 14-17%. Sensex has given a return of approx. 17% since inception i.e 1979-80 till...

  • Q

    Iwant to invest rs10l free of risk ! Shd i go for bank fd's or as the bank suggest " guaranteed income plan" ? Please guide .


    Yes bank returns are fixed....

  • Q

    My daughter 18 yrs. old is studying at IIT Madras for engineering. She is a tax payer in the 20% slab. I wish to get her a LIC policy at an early age. The agent recomends JEEVAN ANAND from LIC of India. Kindly advise the best options.


    Hello, Jeevan Anand is a with-profit plan by LIC which has an insurance component as well. It is always recommended not to mix insurance and...

  • Q

    I am 40 years old working in private company. Want to invest open ended fund Rs. 2000 per month. Kindly suggest


    The scheme that you should invest into would depend upon your time horizon. If you can stay invested for long term ( 7 yrs + ) then you shou...

  • Q

    I am planning to invest a lumspum of Rs 10000 in Mutual Fund for 2 years horizon. Please suggest me some good funds which will provide me maximum returns. I am ready to bear the risk. Would appreciate your advises. Thanks


    For a period of 2 years, I would suggest that you invest in a dynamic bond fund. However, since you have mentioned that you wish to take ris...

  • Q

    Dear sir/madam i am Dhananjay Surve from mumbai .I have got placement through my engineering college and working sience last 2 months .Ia am 22 years old ,i s investing in sip is good for me .As iam looking for time period of 3 to 5 years from now for investment ,which will be the best fund and what other investment option will be best .i am looking for 2 to 2.5 k per month investment.


    Invest the entire amount in a balanced fund. Its a good way to get an understanding about mutual fund working and investments. Invest in Tat...

Explore Moneycontrol

Copyright © e-Eighteen.com Ltd. All rights reserved. Reproduction of news articles, photos, videos or any other content in whole or in part in any form or medium without express written permission of moneycontrol.com is prohibited.