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Old 29th October 2007, 11:47   #1
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Default Why interest on first EMI?

I was doing the mathematics for the loan I need for my new car, and while doing that I felt something is wrong or I am missing something.

If I take the loan of 500000, with interest rate of 12% reducing, for 3 yrs, my EMI comes out to be 16607 Rs.

Out of this Bank take one EMI as part of down payment. and rest 35 PDC's.

Why should I pay interest (5000 Rs) on the EMI (Principal : 11607 Rs) which I am paying right at the time of purchase.

It make sense only if loan payment starts one month after the purchase.

Am I missing something
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Old 29th October 2007, 12:08   #2
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You indeed are missing something.

The interest paid is on the principal amount outstanding of the loan. In fact the first EMI would have the highest amount of interest because the amount of principal outstanding is the highest.

The loan repayment does not start after one month. That would be the case if you have taken a post EMI scheme.

In layman's terms:

There are two types of EMI's that can be taken. The first one (the one that you have taken) takes the EMI payments at the begining of the month. The second one (which you refer to when you say that the first EMI should be after one month of purchase) is one in which you make the payments at the end of the month. Almost universally the first EMI system is followed. You pay the interest on the principal outstanding and a part of the principal. That is why the first month would have the highest interest component and this gradually decrease to a few hundred bucks in the last payment.

Last edited by thefreak : 29th October 2007 at 12:12.
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Old 29th October 2007, 14:32   #3
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Originally Posted by thefreak View Post
You indeed are missing something.

There are two types of EMI's that can be taken. The first one (the one that you have taken) takes the EMI payments at the begining of the month. The second one (which you refer to when you say that the first EMI should be after one month of purchase) is one in which you make the payments at the end of the month.

Almost universally the first EMI system is followed.
sorry it is not universal system. it is unique to private banks which loot customers. when one takes loan interest is calculated from the date of disbursal of loan. so one the first day when loan is just given to customer what interest accrues? and for what period?
interest is for period not for split second . so at the end of the month from the date of disbursal one has to pay interest for 30 days for entire loan amount. what these banks are doing is they are calculating it for 30 days but collecting it on the first day. that is rates quoted look low. because in fact the bank is actually disbursing the guy less amount than what is made out to be.
in this case the loan amount is 500000, but actually the bank is giving a loan of Rs 483393 not 5 lakh. the actual interest rate is 14.37% not 12% for post EMI Scheme.
No PSu bank does this. it is nothing but deceiving gullible customers.

Last edited by rkg : 29th October 2007 at 14:34. Reason: coorecting spelling
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Old 29th October 2007, 14:54   #4
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Uh oh! Maybe some PSU banks don't do this but when I approached SBI for a loan this was I was offered a starting month EMI!!

And by the way: You are going to pay 60 EMI's every month. The EMI paid in pre month EMI's are lesser than the EMI's paid in the post month EMI's. That accounts for some of the difference.

For example on a loan of 11 lakhs @ 10.75% pre month EMI scheme would get you an EMI of 23,568 and post month EMI would get you an EMI of 23,779. Net payment in starting month EMI would be 1,414,116.81 and in ending month EMI it would be 1,426, 784.94 (inclusive of all payments). The difference between the schemes is not as much as people make it out to be.
An ending month EMI of 23,779 dicounted at 6% (risk free rate of return) will give you
23,660 starting month EMI.
Discount rate = 8% (PPF return) and the ending month EMI becomes equivalent to 23621 starting month EMI.
Discount rate = 12% (something would return this much too ) and ending month EMI becomes equivalent to 23,543 starting month EMI.


PS: I can tweak the numbers to show you which scheme is better and give you convincing reasons too. The question is which one do you want to be better ?

PPS: And dont start looking at things from the banks perspective. Look at it from your perspective.
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Old 29th October 2007, 17:41   #5
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SBI usually has the normal EMI. You pay at the end of the first month. That's what I have and that's what one should take. Pre-EMI is a ripoff.

what RKG has said is what happens. You want a loan for 5,00,000/- They say EMI is 15000/- (for example). first EMI is paid when you take the loan itself. They will say its full Principal.

So effectively the loan is for 4,85,000/- Now do the interest calculation for this amount. Your % shoots up. ICICI, HDFC, Kotak.. all the banks who have tie ups with the dealers will be giving you these rates. 9%, 9.5%....

freak: checkout if the first EMI is fully against principal or has an interest component to it? If its fully against principal then what I or rkg said holds true.

Simple logic says you pay interest for the money borrowed for a certain period of time. You don't pay Interest when you take the loan itself.
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Old 30th October 2007, 09:43   #6
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Quote:
Originally Posted by csentil View Post
SBI usually has the normal EMI. You pay at the end of the first month. That's what I have and that's what one should take. Pre-EMI is a ripoff.

what RKG has said is what happens. You want a loan for 5,00,000/- They say EMI is 15000/- (for example). first EMI is paid when you take the loan itself. They will say its full Principal.

So effectively the loan is for 4,85,000/- Now do the interest calculation for this amount. Your % shoots up. ICICI, HDFC, Kotak.. all the banks who have tie ups with the dealers will be giving you these rates. 9%, 9.5%....

freak: checkout if the first EMI is fully against principal or has an interest component to it? If its fully against principal then what I or rkg said holds true.

Simple logic says you pay interest for the money borrowed for a certain period of time. You don't pay Interest when you take the loan itself.
Nopes first EMI has an interest component. And a heavy one at that.
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Old 30th October 2007, 09:49   #7
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Nopes first EMI has an interest component. And a heavy one at that.

Also the simple logic is true if you are paying the same amount of money whether it is the begining of the month or end of the month. The difference here is that you are paying lesser amount for the same loan if you are paying begining month EMI.

Also ending month EMI should be cheaper if you use the discounting factor (discounting from the month end to the month begining) as the same as the interest on your loan then you will find that both the EMI's would turn out to be exactly equal.

I feel the difference between begining month and ending month EMI is not as much as it is made out to be.
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Old 30th October 2007, 09:49   #8
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Old 30th October 2007, 09:50   #9
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@Mods: Something wrong here. I am editing my posts and they are getting posted as new ones! Can some mod please delete my posts above (please let the longest one stay)
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Old 30th October 2007, 09:51   #10
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Quote:
Originally Posted by csentil View Post
Simple logic says you pay interest for the money borrowed for a certain period of time. You don't pay Interest when you take the loan itself.
Quote:
Originally Posted by thefreak View Post
Nopes first EMI has an interest component. And a heavy one at that.
Typical of our private banks, they are no better than private loan sharks. As long as majority of us do not look into the fine print, they will continue to cheat.
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Old 30th October 2007, 12:08   #11
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Originally Posted by csentil View Post
checkout if the first EMI is fully against principal or has an interest component to it? If its fully against principal then what I or rkg said holds true.
Thats what my point is, first EMI has the biggest per month interest... I will check with PNB and State Banks for the same.

I clearly see its as ripoff.... Recently I converted a citibank credit card payment of 50K into EMI and they clearly told me the first EMI will be one month after the purchase. Which makes sense
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Old 30th October 2007, 12:24   #12
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Quote:
Originally Posted by rkbharat View Post
Thats what my point is, first EMI has the biggest per month interest... I will check with PNB and State Banks for the same.

I clearly see its as ripoff.... Recently I converted a citibank credit card payment of 50K into EMI and they clearly told me the first EMI will be one month after the purchase. Which makes sense
Mate! rather than speculating and calling those guys dastards (which they are) lets do some calculations. Send me the details of the loan you are taking and lets work out the amount that you are paying extra etc. I am sure the ending month EMI scheme would be a winner but the difference would not big enough to warrant calling them dastards (there are plenty of other reasons though )
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Old 30th October 2007, 12:54   #13
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Originally Posted by thefreak View Post

And by the way: You are going to pay 60 EMI's every month. The EMI paid in pre month EMI's are lesser than the EMI's paid in the post month EMI's. That accounts for some of the difference.

For example on a loan of 11 lakhs @ 10.75% pre month EMI scheme would get you an EMI of 23,568 and post month EMI would get you an EMI of 23,779. Net payment in starting month EMI would be 1,414,116.81 and in ending month EMI it would be 1,426, 784.94 (inclusive of all payments). The difference between the schemes is not as much as people make it out to be.
An ending month EMI of 23,779 dicounted at 6% (risk free rate of return) will give you
23,660 starting month EMI.
Discount rate = 8% (PPF return) and the ending month EMI becomes equivalent to 23621 starting month EMI.
Discount rate = 12% (something would return this much too ) and ending month EMI becomes equivalent to 23,543 starting month EMI.


PS: I can tweak the numbers to show you which scheme is better and give you convincing reasons too. The question is which one do you want to be better ?

PPS: And dont start looking at things from the banks perspective. Look at it from your perspective.
this is all financial jugglery that these banks do. they want to confuse the customer like cell companies are doing. what ever plan one chooses he finally ends up paying certain minimum amount to cell companies in all plans.
as you said there is huge component of interest in first EMI in pre EMI scheme. it is fine. can you elaborate how interest is accrued on day one itself? how was interest calculated and for what period? deducting approximately 9854/= rupees on day one as interest is nothing but plain cheating( as per your example 11 lakhs @10.75% per year, the interest per month) but actually they are giving a loan of 1100000-23568=1076432, collecting 9854 as interest on first day. isn't it cheating?
SBI does not charge pre EMI at all. you might have gone through an agent at dealer who quoted this. all the agents get commission from private banks where as PSU banks does not have the flexibility to offer discounts. in case of SBI all car loans are not approved at the bank branch at all. they send to one central regional office/ main branch( this is what by bank guy told me in bangalore) which sanctions it. SBI calculates interest on daily reducing balance method not even monthly reducing method
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Old 30th October 2007, 13:01   #14
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Financial jugglery I agree.

First month EMI payments I agree. Unwarranted interest component. But then your loan ends a month earlier doesn't it? That is the way the instrument is made. You can list thousands of pros and cons of all the financial instruments ever made.

As I said in my earlier post the difference works out to not that much if you take a wholistic picture. the EMI payments in the ending month EMI scheme are more. That is the fact that balances some of the cons out.
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Old 30th October 2007, 13:32   #15
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Quote:
Originally Posted by thefreak View Post

And by the way: You are going to pay 60 EMI's every month. The EMI paid in pre month EMI's are lesser than the EMI's paid in the post month EMI's. That accounts for some of the difference.

For example on a loan of 11 lakhs @ 10.75% pre month EMI scheme would get you an EMI of 23,568 and post month EMI would get you an EMI of 23,779. Net payment in starting month EMI would be 1,414,116.81 and in ending month EMI it would be 1,426, 784.94 (inclusive of all payments). The difference between the schemes is not as much as people make it out to be.

some simple math as per data given by you
Pre EMI scheme
EMI = 23568
No of months = 60
total out go= 1414080
actual interest paid= total out go- actual loan taken ( here 1100000-23568 first EMI as you are paying on first day it is as good as your making down payment and is fact) 1100000-1076432= 337648 is the total interest paid by you

Now Post EMI scheme
EMI = 23779
No of EMI = 60
total outgo = 1426740
actual interest paid= 1426740-1100000= 326740

Extra interest paid in pre EMI scheme for lower loan amount is
337648-326740= 10908 /=

in post EMI scheme one take more amount as loan and pays it over more duration of 30 days.

now the III senario ( this what actually the bank will get in pre EMI scheme)
(if a guy goes to PSU bank and makes a down payment of 23568 first EMI of pre EMI scheme and takes the rest as post EMI loan)

loan amount = 1076432 ( real loan amount)
rate = 10.75%
EMI =23568
duration= 59 months ( real loan duration)
total out go= 23568 X 59 = 1390512 ( real out go)
actual interest= 1390512-1076432 = 314080 ( actual interest that should have been paid)
what the bank is really collecting = 337648
excess = 337648-314080=23568
i hope iam clear
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