27th January 2023

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Relief from compound interest

An exemption from the compound interest lien, on MSMEs and personal loans of up to Rs 2 crore can be a great relief to borrowers, especially those whose loans are in their early years repayment, because its interest component is a currency. This would help reduce the burden on the borrowers as they have to pay the contractual interest rate on the loans.

  • Since the moratorium on loan repayments announced by the Reserve Bank of India was not an exemption, borrowers must pay interest and interest on the accumulated amount.
  • Although the central government has announced that it will pay the compound interest bill, clients still have to take responsibility for the interest accrued during the six moratorium period.
  • Sources said the exemption is expected to cost the government between Rs 6,000 to 7,000 million. This is how it can work:

What do you have to pay?

  • The first thing consumers need to understand is the difference between interest and interest in interest. It should be clear that clients will have to pay the interest on their outstanding loan during the period for which they have opted for the moratorium.
  • So if you had an outstanding loan of Rs 50 lakh for a remaining period of 19 years (228 months) at the beginning of the default period and your interest rate was 8%, the interest cost for the six month period of the moratorium would approach 2 lakh rupees. This will have to be paid for.

What is waived?

  • Continuing with the example above, banks will not charge interest on this interest amount of Rs 2 lakh from clients and the government has offered to pay it.
  • Therefore, banks would not add the interest amount of Rs 2 lakh to their principal due of Rs 50 lakh and would not calculate a new EMI at the prevailing interest rate.

So how will the amount of interest accrued during the forbearance period be paid?

  • Since the government offered to pay the interest on the interest component, banks and real estate finance companies can simply divide the interest component – Rs 2 lakh in this case into 228 monthly payments. Which means that your ECM can increase by 877 rupees per month.

How much do you save

  • Continuing with the example above, if the bank had added the interest component to its overdue principal and charged 8% for 228 months, its EMI would have increased by Rs 1,709 per month.
  • However, since no interest is being charged on this now (as the government has offered to pay), your EMI can only increase by Rs 877 per month. Or a monthly saving of Rs 832 over the 228 month period in this case (due to interest from interest waiver).
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