Pre-EMI for Under Construction Properties

money-2387090_960_720.jpgWhen buying an under construction home, developers often seek payment on the basis of the stages of construction completed. Catering to such requirements, Home Finance Companies (HFC), facilitate partial disbursements of the sanctioned loan periodically, in tune with the developers demands. For these partial loan disbursements, a borrower would be required to pay what is called as a “Pre-EMI”.

Applicable only for under construction properties, Pre-EMI’s are very different from regular EMIs in composition and tax treatment. A basic understanding of their working is thus essential for effective loan.

How Does Pre-EMI Differ From EMI?

For under construction properties, the sanctioned loan amount is disbursed to the builder as and when the stipulated work is completed as per the agreement. For this periodic partial disbursement, the interest that is paid, till the completion of the property is known as Pre-EMI.

A regular EMI begins after the sanctioned loan amount has been fully disbursed. Irrespective of whether it is an Advance Disbursal Facility (where the full loan amount is disbursed at one go) or the case of Pre-EMI, a regular EMI would begin from day one of the complete loan disbursement.

Unlike the regular EMI which comprises of a principal and interest component, Pre- EMI comprises of only the interest portion.

Calculating Pre-EMI

Vikas has just signed an agreement with a developer for an under construction property to be completed in 12 months. He has been sanctioned a loan amount of Rs. 12 lakhs at 10% interest rate p.a., for 20 years. The builder requires Rs. 1 lakh every month till final completion.

The simple interest payable per month is: Rate of interest per annum x (Total loan outstanding at the end of current month) / 12.

Here is an example illustrating how Vikas’s monthly Pre EMI is arrived at.

Month Loan Outstanding At Beginning of Month Loan Disbursed Interest Payable Loan Outstanding At End of Month
Jan 2010 1,00,000 833.00 1,00,000
Feb 2010 1,00,000 1,00,000 1666.67 2,00,000
March 2010 2,00,000 1,00,000 2500.00 3,00,000
April 2010 3,00,000 1,00,000 3333.33 4,00,000
May 2010 4,00,000 1,00,000 4166.67 5,00,000
June 2010 5,00,000 1,00,000 5000.00 6,00,000
July 2010 6,00,000 1,00,000 5833.33 7,00,000
August 2010 7,00,000 1,00,000 6666.67 8,00,000
Sep 2010 8,00,000 1,00,000 7500.00 9,00,000
Oct 2010 9,00,000 1,00,000 8333.33 10,00,000
Nov 2010 10,00,000 1,00,000 9166.67 11,00,000
Dec 2010 11,00,000 1,00,000 10000.00 12,00,000

* Fixed rate of interest has been assumed for illustration purpose and simplicity.

Total interest payable over 12 months by Vikas would be Rs. 65,000. Thus, the average Pre-EMI per month works out to be Rs. 65,000/12 = Rs. 5,416. Vikas would thus be paying only the interest for the first 12 months. His actual EMI and loan tenure would begin only thereafter, for 240 months.

 So Is Pre-EMI a Good Option?

Well, technically speaking, pre- EMI does get a bit more costly considering that you pay an extra bit of interest in the pre construction phase, plus a regular EMI thereafter. Nevertheless, many experts still believe that it could serve as a good option.

The Pros

  • Pre-EMI comprises only of the interest portion and is thus a lesser amount than your EMI. If you are having a tight financial situation and are anticipating future gains, you could pay a pre-EMI and still get to purchase a home that you want.
  • Loan disbursements and hence payments to the builder in a phased manner over a period of time, could add quite a pressure on the builder to finish the project on time.
  • With a pre-EMI, your actual EMIs don’t start right away. So the difference between the two could be used to invest in high yielding investments and generate some returns.

The Cons

  • There is an extra interest payment over and above the regular EMI payments, which you would be paying. Of course there is a tax deduction available, but that is possible only after you take possession and that too in 5 subsequent years.

Tax Implications

The brighter side to all the extra interest that you pay through a Pre-EMI is the tax deduction under Section 24.

All interest paid as pre-EMI prior to completion of construction, is a deductible in 5 equal installments, in the five subsequent years, beginning from the year in which the construction is completed. Say for example, you have paid a total of 2.5 lakhs, in the pre construction period as Pre EMI. Then Rs. 50,000 (i.e.2, 50,000/5) would be the tax deductible in each year for the next 5 years.

There would be no tax benefit available on any principal repayment, if at all done, in the pre-completion phase. Principal repayments on a loan made in the years after the construction of the property eligible for deduction up to a limit of Rs. 1 lakh per annum.

Also while claiming pre-EMI tax benefits the total interest component (i.e. the current year post-possession interest component + the previous year’s 20% pre-EMI interest component) cannot exceed the Rs. 1.5 lakhs.