POSTED BY July 17, 2014 10:54 pm COMMENTS (9)

ONI took a personal loan of 5.75L from a private bank at 12.5% for 2 years. I’ve already paid 8 EMI (1 EMI=Rs. 27202)

Now I’ve money to prepay the remaining loan and end it. However, when I calculate it seems if I continue the loan for the full tenure I would be effectively be repaying the bank at 6.25% (annual rate of return) for 2 years.

I am confused if it makes sense to continue with the loan for the full duration and invest the money elsewhere or should I prepay the loan.

Kindly advise.

Thanks, Anand

Hi Hemanth,

I completely understand what you are saying on how Personal loan works. Also, the bank provided me a work sheet on all the EMIs and how much of the EMI goes into interest for each month. Plus there were no joining/pre-closure charges (corporate discounts).

But what I still don’t understand is how is this loan expensive? It seems I’m conceptually wrong or I am not doing the calculations right as the world says they are expensive. Kindly help me understand.

My premise is – Had I invested 5.75L somewhere and got back 6,52,848 (i.e. 27202*24) after 2 years, my rate of return would have been 6.5%, isn’t it? Then how is this expensive?

If you have gone through my description on how personal loan works…. after the 1st EMI, the principal under consideration is decreased…. did you understand why is it son ??

If you have gone through my description on how personal loan works…. after the 1st EMI, the principal under consideration is decreased…. did you understand why is it so ?

If you have gone through my description on how personal loan works…. after the 1st EMI, the principal under consideration is decreased…. did you understand why is it so ??

EMI can be calculated by yourself using ‘PMT’ function in Excel

You can use PV, FV along with PMT to know the illustrations I made above

This article might help on how the EMI works

https://www.jagoinvestor.com/2011/04/loan-amortization-emi.html

This is not how the personal loan works…..

First the EMI is calculated….. After you pay first EMI, some part of the EMI goes for the payment of interest, and some part goes for the payment of Principal.

So, your principal will be less for the second month. Now, some more part of the EMI goes to payment of interest more part (than the first month) goes for the payment of Principal….

So, month on month your principal goes down….. and at last your loan will be paid off….. In starting months, most of the EMI goes to interest and slowly the principal will be reduced….

I know I am confusing you, so let’s see how its works in numbers…. 🙂

Here is how it works….

First month you paid Rs. 27202 as EMI.

Interest on your principal (5,75,000) for 1 month @ interest of 12.5% p.a is Rs. 5989.58. This will be paid from your EMI.

So, remaining Rs. 21212.12 ( 27202 – 5989.58) of your EMI will go for the payment of your principal.

So, by the end of month one you principal goes to Rs. 553787.88 (575000 – 21212.12) from your original 5,75,000

Second month:

EMI – 27202

Interest – 5768.62 (decreased as your principal for 2nd month reduced)

Principal amount repaid – 21433.08

So, end of 2nd month you principal is 5,32,354…..

So, by the end of 24 months your loan will be waived….

For your 1st query….. better close the loan ASAP as the interest rate is 12.5% which is really high…. Also check whether if any pre-closure charges are there….

Loan amount = 5,75,000.

My EMI is 27202.

In 24 months, I pay the bank – 27202*24=6,52,848.

(Reverse calculation) Had I invested 5.75L for 2 years and got 6,52,848 at the end of 2 years, my Annualized Return would have been around 6.5%.

Can you please elaborate how you got that number – 6.25