What is Loan Repayment and How Does it Work?

A loan can be a boon to those who need financial help and availing a loan automatically implies that it should be repaid along with the decided interest rate. Read to know what loan repayment is and how it works.

What is Loan Repayment?

Returning the loan amount borrowed to the lender is known as loan repayment. But first, let us take a look at what loans are.

What are Loans?

A loan refers to a sum of money that is lent by banks, NBFCs or other lenders to a borrower with the intention of receiving it back with interest over a period of time. Loans can be secured or unsecured. Secured loans are those that require a collateral or security in order to be disbursed. For example, if you wish to avail a home loan, the house in question will be in the lender’s name until the loan has been fully repaid.

Unsecured loans are those that do not require collateral or security for disbursal such as personal loans.

How Does Loan Repayment Work?

The act or process of repaying the borrowed amount to the lender is known as loan repayment. When a lender provides a loan to a customer there is inherent risk involved. In order to mitigate this risk, an interest rate is imposed on the loan. The customer will have to pay back the loan in installments known as EMIs or Equated Monthly Installments. EMI consists of a portion of the principal amount that is borrowed along with interest amount.

Basically, EMI = Principal Amount + Interest Amount

It is interesting to note that the principal amount and interest amount are not equal in an EMI, in fact during the initial loan repayment period, the interest amount will be higher and will reduce as the repayment term progresses and the principal amount increases. Additionally, the EMI amount can also be fixed or floating. Fixed EMI payments are when the amount to be paid does not vary during the loan repayment term. When it comes to floating (also known as variable or flexible repayment) options, the EMI amount may vary depending on the market value and other fluctuations.

Types of Loan Repayment Methods

Everybody’s financial status and requirements will vary including their loan repayment abilities. There are a number of different types of loan repayment methods available in the market today.These include-

  • Delayed EMI Payments
  • In this case, the borrower need not have to pay loan EMIs for a set period of time at the start of the repayment tenure. Also known as moratorium period, this option can be availed from a few months to a few years. However, a predetermined amount may have to be paid during the moratorium.

  • Step-Down/Flexible Repayment Plan
  • In this plan, the EMI amount decreases as the repayment term progresses. This means that the installment amount will be high in the initial years and is great for those looking to retire soon or those who are expecting a reduction in their income with time.

  • Step-Up Repayment Plan
  • As opposed to the previous option, in a step-up repayment plan, the EMI amount increases with time and will be less in the initial years. If you are somebody who is expecting a large income in the future then this repayment plan might be good for you.

  • Loan Foreclosure
  • In this time of repayment plan, a lump sum can be paid after a certain number of EMIs have been paid to completely repay the loan amount. However, this option is subject to terms and conditions and may even result in the borrower having to pay a penalty.

    Given above are just a few of the repayment options available. However, borrowers must keep in mind that the repayment term will vary based on the type of loan that is being availed, the lender’s terms and conditions, and other factors. Not every type of loan can be paid off by using the above repayment options.

Loan Repayment Schedule

As mentioned previously, your EMIs will be paid over a certain duration of time and an amortization schedule or table is extremely important in this regard.

What is Amortization Schedule

A table of all the periodic loan payments made over the repayment term showing the amount of interest as well as principal amount that is a part of each payment is known as amortization schedule. Generally, early on in the loan repayment schedule, a major part of the EMI will be the interest amount and later on the principal amount will make up a majority of the payment.
Let us understand this better with an example.

Personal Loan Repayment Schedule

Personal loans are one of the most popular loans that are availed by applicants today. For. eg, Mr. Amit borrowed Rs.5,00,000 from a popular lender at an interest rate of 8% for a repayment term of 2 years. His personal loan amortization schedule will look like this -

Year Opening Balance Interest Principal Closing Balance
2021 Rs. 5,00,000 Rs. 20,603 Rs. 1,37,689 Rs. 3,62,311
2022 Rs. 3,62,311 Rs. 19,898 Rs. 2,51,466 Rs. 1,10,845
2023 Rs. 1,10,845 Rs. 2,227 Rs. 1,10,841 Rs. 0.00

The total interest to be paid is Rs. 42,728 while the EMI amount is Rs. 22,614 per month.

If you wish to find out your EMI schedule, you can easily do so using EMI calculators available online. All you need to do is use the slider to provide the amount you wish to borrow, the interest rate imposed, and the repayment tenure of your choice.

In Conclusion

Availability of a loan is an act of responsibility as it is understood that the amount will have to be repaid. There are a number of loans available in the market today with differing terms and conditions. Customers will have to choose a loan that suits their requirements and ensure that the loan repayment is done on time. If you are looking for a personal loan at competitive rates and advantageous terms and conditions, visit the Money View website or download the loan app to apply today.