Introduction
Retail loans are financial products offered by banks and Non-Banking Financial Companies (NBFCs) to cater to the diverse credit requirements of individual borrowers. These loans serve various purposes, such as purchasing a home or vehicle, funding higher education, managing personal expenditures, or availing credit against gold. Additionally, loans extended to Micro, Small and Medium Enterprises (MSMEs) for operational or expansion needs are also categorized under retail loans.
Loan Repayment: Definition and Components
Loan repayment refers to the process of returning the borrowed sum to the lender in accordance with the agreed terms and schedule. Typically, this is executed through Equated Monthly Installments (EMIs), which comprise two primary components:
- Principal – the original amount borrowed
- Interest – the cost of borrowing, calculated on the outstanding principal
Types of Loan Repayment Structures
Retail loans offer various repayment structures to suit the financial preferences and capabilities of borrowers. The most common types include:
- Fixed-Rate Loans
In a fixed-rate loan, the interest rate remains constant throughout the fixed tenure. This ensures predictable EMI amounts, facilitating easier budgeting and financial planning. Unlike variable rate loans, fixed-rate loans are not influenced by market fluctuations or changes in benchmark rates. - Floating-Rate Loans
These loans carry an interest rate linked to an external benchmark, such as the Reserve Bank of India’s (RBI) repo rate or the lender’s base rate. As the benchmark rate changes, the interest rate and EMI adjust accordingly—resulting in either an increase or decrease in repayment obligations over time. - Balloon Payment Loans
A balloon loan requires smaller periodic payments (usually covering interest and a portion of the principal), with a substantial lump sum—referred to as the “balloon payment”—due at the end of the loan term. This structure is often used in certain mortgage or commercial loan arrangements.
EMI Calculation: Formula and Illustration
EMI (Equated Monthly Installment) refers to the fixed payment made by the borrower each month towards loan repayment. Each EMI includes both interest and principal components, with the interest portion being higher in the initial stages of the loan and gradually decreasing as the principal reduces.
EMI Formula:
EMI= [P×R×(1+R)^N] / [(1+R)^N-1]
Where:
- P = Principal loan amount
- R = Monthly interest rate (annual rate divided by 12)
- N = Loan tenure in months
Example Calculation:
Assume a loan of ₹1,00,000 (P), at an annual interest rate of 10% (R = 0.10), for a tenure of 12 months (N = 12):
- Monthly interest rate = 0.10 / 12 = 0.008333
- EMI = ₹8,771.64 (approx.)
Repayment Methods
Retail loan repayment is typically facilitated through one of the following methods:
- Salary Credit Account: Borrowers may opt to credit their salary to the account from which the loan was availed, ensuring timely deduction of EMIs.
- Salary Mandate: A mandate may be submitted to the employer to directly deduct the EMI from the borrower’s salary and remit it to the lender.
- Post-Dated Cheques (PDCs): Borrowers issue a series of PDCs in favour of the lender, covering the EMI schedule.
- Electronic Clearing Services (ECS) / NACH: Borrowers authorize automatic debit of EMIs from their account through ECS or the National Automated Clearing House (NACH) facility.
Conclusion
Understanding the nuances of retail loan repayment structures is crucial for efficient financial management and maintaining a healthy credit profile. Borrowers should carefully evaluate the repayment options available to them and choose the one that best aligns with their financial goals and cash flow patterns.
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