- Date : 26/03/2023
- Read: 3 mins
An insight into loan repayment cost and its calculation
The interest rate is the single most important factor for any loan applicant. But to avoid loan default and unnecessary pressure on your budget, you must consider the loan repayment cost. It goes beyond the interest cost and gives you a more holistic picture of the cost of borrowing.
To gauge the repayment cost of your loan, you must consider the basic components of the loan. This includes:
- Loan amount: It is the amount of money you have applied from your bank or financial institution. You can think of it as the principal amount, on which the interest will be applicable as per the agreed rate.
- Loan tenure: The repayment tenure of your loan is another important factor that decides the cost of your loan. If you choose a longer loan tenure, your loan will remain due for a longer period, which will result in higher accruals of interest against the outstanding principal amount. The loan amount also has a bearing on the loan tenure. You may opt for a longer repayment period for a home loan as the loan amount would be high. Personal loan amounts are smaller in comparison, and accordingly, so is the repayment period.
- Annual percentage rate: APR is the total cost of borrowing a loan, expressed in percentage. It includes the interest rate but also various other expenses like the loan processing fee, verification charges, tax, etc.
Based on these factors, you can now find out (i) your payment amount per month and (ii) the total cost of borrowing the loan.
Payment per Month
By using the loan amount, interest rate, and loan tenure, you can calculate the EMI for the loan. This is done with the simple formula,
P x R x (1+R)^N / [(1+R)^N-1], where P is the loan principal amount, N is the loan tenure in months, and R is the monthly interest rate. For example – the interest rate is 15% i.e., the monthly interest rate is 1.25%. The loan tenure is 36 months. And the principal amount is Rs 5 lakhs. The EMI for this loan will be approximately Rs 17,120.
Total Cost of Borrowing
In the above example, the interest cost of the loan would amount to Rs 1,16,320. Let us assume that processing fees and other recurring or one-time charges amount to Rs 33,680. When we add this amount to the interest cost of 15%, the APR of the loan amounts to 19.68%. This is the total, or actual, cost of borrowing the loan.
Both these calculations help you to estimate the repayment cost of your loan, both in terms of the EMI as well as the overall cost. While a loan is useful to meet your financial needs, know your monthly outflow and total repayment costs to ascertain that the loan is indeed affordable for your personal finance.