Layman Series: Moratorium – Understanding The Term

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The word moratorium is often used when discussing banking, loans and finance. The meaning of the term is not as morbid as it sounds. It simply means a break in an activity. Within the banking sector, moratorium or moratorium period implies the duration during which the borrower is not required to pay EMI. It is the breathing space banks provide borrowers to sort out re-payment plans, arrange finances, and determine expenditure to get ready before the regular EMI payment schedule begins. Moratorium period is applicable only to home loans and education loans.

 

When an individual applies for a home loan, most lending institutes grant them a moratorium period before they begin re-payment towards the loan. This duration acts like a cushion, giving space and time to the borrower to get themselves in shape financially. However, the moratorium period is not devoid of the interest payment. The interest amount that is incurred during the moratorium period gets spread across the entire re-payment schedule.

 

For instance, let us assume you have applied for a loan of 10 lacs at the rate of 10% interest for five years and the bank has given you a moratorium of three months.  Going by this data, you need to pay a monthly EMI of Rs. 21,247/-. During the moratorium period, you will not pay any amount towards the loan. However, the interest for that period (three months) is calculated and spread over the re-payment amount. Thus, from the fourth month, you will pay Rs. 21,685/-. The EMI amount will go up slightly because the sum of the interest incurred during each month of the moratorium period will be spread over the remainder tenure and added to the original EMI.

 

In case of students who apply for an education loan, the moratorium period is higher. As students cannot re-pay the loan till they finish the course and begin earning, lending institutes give them a higher grace period. Students apply for loans before the start of the course. The loan amount goes towards their tuition fee, accommodation and other charges. After the students complete the course, they need to begin with their EMI payments. For the moratorium period, the lending institutes calculate the interest rate for each year and add it to the principle amount. The EMI and interest is further calculated on this amount for which they have to begin regular payments.

 

For instance, suppose an engineering student takes a loan of Rs. 5,00,000/- at the rate of 10% for a tenure of five years. The student takes four years to complete the course. The bank will calculate the interest incurred on the principle amount for each year (50,000). The sum of the interest amount of each of the four years will be added to the principle amount at the end of the course. It is on this sum that the bank will calculate interest and EMI for the student to pay at the end of the course. Thus, the principle amount becomes Rs. 7,00,000/-.

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