Popular culture says, it’s good to rest. The same principle is sort of true when it comes to your money too. How so?
Read on, to find out.
Rest: When we talk about rest here, we aren’t talking about relaxation. Believe it or not, rest here is a banking term and used in the framework of a reducing balance loan. And it’s something you should know about if you’ve ever taken a loan or plan to take one.
In short, rest defines the periodicity at which the principal amount is reduced as you repay the loan. Generally speaking there are four types of rest; daily, monthly, quarterly and annual. So, in annual rest, the bank will recalculate the outstanding loan amount at the end of one year or 12 months.
Even if you pay the Equated Monthly Installment (EMI) every month (and the amount you actually owe reduces every month), the outstanding loan amount won’t be adjusted till the end of the year.
How it works: Let’s take the example of monthly rest, to explain the term. A monthly rest recalculates the reduced principal after each EMI, and then applies the interest rate on the reduced principal. So, if you take a loan of say Rs 5 lakh at an interest of 10 percent per annum on a monthly rate basis for 20 years, your first month's EMI stands at Rs 4826.
This EMI is made of two components; one is the principal amount of Rs 659 and the interest part of Rs 4176. So, with monthly rest, after the first month, your outstanding principle amount is reduced by Rs 659 and the interest is reworked on new outstanding principal amount.
Unlike monthly rest, where the repaid principal is adjusted monthly, with annual rest, it is adjusted after a year. With daily rest, your loan interest is calculated based on the previous day’s outstanding balance. While with quarterly rest the benefit of a lower principal comes in only after three months. Hint: you want to get the benefit of lower principal as soon as possible, and not after a year or so.
Which should you opt for:
The interest you pay is least in daily rest, a little higher in monthly rest, a little more higher in quarterly and highest in annual. If you have bank "A" offering you 12 percent per annum on annual rest and bank "B" offering you a loan at 12 percent per annum on monthly rest. Go for monthly rest option, it will work out cheaper.
For instance, if you borrow Rs 5 lakh at 12 percent for 20 years, the total interest you pay on monthly rest is Rs 8.21 lakh and it’s Rs 8.38 lakh with annual rest. So, while taking a loan, opting for the right type of rest becomes important.