What is Principal Amount in Home Loan

Your home loan EMIs depend on the principal amount and the interest rate

The EMIs you pay towards your home loan have two components: the principal amount and the interest. In the initial months of your repayment, the bigger component in your EMI will be the loan's interest. However, this will reverse as the loan term ends, with the principal amount becoming the more significant component. But what is the principal amount, and how is it calculated?

Components of a home loan EMI

If you are paying home loan EMIs, it is imperative you understand the different parts to it.

1. Interest amount

Banks charge interest on different loans. The interest rate is usually fixed, compounded, and applied to the total loan amount. The interest rate component tends to take the bigger pie out of your EMI in the initial years of repayment.

2. Principal amount
 

The principal amount, in the context of a loan, refers to the initial sum of money borrowed from a lender. It represents the total loan amount at the beginning of the loan term. As you make repayments, the principal amount gradually reduces, reflecting the portion of the loan that has been paid off. Eventually, when all repayments are completed, the principal amount reaches zero, indicating the full repayment of the loan.

How to calculate the principal amount?

Assume you have taken a loan of ₹5 lakh, and your first EMI was ₹20,000. Once you make the payment, however, your principal amount doesn't become ₹4.8 lakh as there is an interest component. There are two ways you can make this calculation. You can do the math manually or use an online calculator.

Using the Home Loan calculator, you can see the interest and the principal amount components throughout your loan tenure. Remember, though, that the ratio of the interest and principal components will keep changing during the term.

Prepayment of home loans

Some banks allow you to prepay a part of the loan during the tenure itself. In those scenarios, you are paying towards the principal amount of the loan. When the principal amount of the loan decreases, the interest component also decreases, although the interest rate remains the same.

Let's take an example to understand this:

For instance, assume that you have paid ₹10 lakh out of the ₹25 lakh home loan you have taken. Since you have paid ₹10 lakh, the principal amount you must repay will shrink to ₹15 lakh. The rate of interest will stay the same. However, the amount you pay as interest will decrease as now you are paying interest for ₹15 lakh and not ₹25 lakh.

Foreclosure of loans

Some banks also allow you to close the loan completely. On such occasions, you will need to pay the outstanding amount plus the foreclosure charges, if the bank has any. In the above example, that would be ₹25 lakh plus charges. You wouldn't need to pay interest further as there is no principal amount left after payment.

How to choose a loan amount?

The loan amount you choose is the principal amount of the loan. You should choose the loan amount depending on your need, although remember that the applicable interest will be less if your loan amount is less. However, banks charge a processing fee for your approved loan, and you must pay it regardless of the loan amount you get.

Therefore, choosing a lender that charges less processing fee can help you save money. IDFC FIRST Bank offers zero processing charge if the loan repayment is made through an IDFC FIRST Bank account. Furthermore, IDFC FIRST Bank's loan application process is digital, which reduces the processing time.

Understanding the components of your loan EMI is vital in getting the best offer. You can use tools like a home loan calculator to aid your research.

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.