Moratorium Period is a term you will often hear about in relation to loans, especially education loans and home loans. But sometimes it gets confusing for a common man to understand the concept and make full use of it. In this article, we will first understand what is moratorium period & capitalization of interest and then how the concept applies to education loans, home loans and construction loans.
What is Moratorium Period?
Moratorium Period is a time period during the loan term, generally starting from the date of disbursement of loan, during which the borrower is not required to make any repayment or is required to pay only the interest portion. In other words, the borrower gets principal holiday and may or may not get interest holiday during moratorium period i.e. till the time full EMI starts.
- Principal Holiday – During moratorium period, the borrower is not required to pay back principal amount. Hence, it is called as principal holiday.
- Interest Holiday – The borrower can generally choose whether he wants to pay interest during the moratorium period or not. Different banks have different products. Some products ask you to necessarily pay interest during moratorium while others don’t. If you are not required to pay interest during moratorium period, then it is called interest holiday.
Loan Servicing during Moratorium Period
As discussed above, you are not required to pay principal amount during moratorium period. However, it is sometimes beneficial to pay interest during this time as many banks offer concessional interest rates, if you choose to pay interest during moratorium period.
Capitalization of Interest – In case, you choose not to pay interest during moratorium period, your interest will be compounded monthly/ quarterly and total interest amount accumulated during moratorium will be added to the principal. Hence, you will have to pay higher EMI. For eg. Let us assume, you have taken a home loan of Rs. 10 lakhs for 20 years @12% with a moratorium period of 18 months. In this case, your interest amount (compounded monthly) for 18 months will be Rs. 1,96,147. Now, this amount of Rs. 1,96,147 (capitalized interest) will be added to your principal and your total outstanding will become Rs. 11,96,147 which you will have to pay back in 18.5 years. Hence, your EMI will increase if you choose not to pay interest during moratorium period.
Major Applications of Moratorium Period
Moratorium period is generally offered in such loans where the income producing ability of the asset or the person is restricted for some time, for example in case of education loan the student does not earn during the study course and in case of home loan, the borrower has to wait till the construction of house is over.
1. Moratorium Period in Education Loan
Moratorium period is provided in education loans till the time the student is studying and upto 18 months after completing the course. There can be variations across products of different banks for eg. if it is a 2 years Master’s degree, the student can choose not to pay interest during the study course and after the course if he gets a job immediately, he can start paying full EMI immediately. However, if the student gets a job after 8 months, he can still avoid any repayment during the unemployment period if terms of the loan allow an extended moratorium period.
Tax Benefit on Education Loan
Tax benefits on education loan can be claimed under section 80E on the interest amount paid, from the year in which the individual starts paying interest.
2. Moratorium Period in Home Loan
Moratorium Period in Home Loan is generally allowed upto 3 years from the date of disbursement.
Ready-to-move-in Property : In case of ready to move in properties, generally your EMI will start immediately. However, some banks may allow moratorium period of upto 18 months during which you are supposed to only pay interest portion.
Under-Construction Property : In case of under-construction properties, you will be allowed a moratorium period of upto 3 years during which you will have to pay pre-emi (interest only). However, some banks allow you to pay full EMI right after the disbursement.
Construction of House : In case you want to take home loan for construction of your own house, you can be allowed a moratorium period of upto 18 months during which you will have to service only the interest amount. Whether the construction is completed or not, full EMI will start after 18 months.
Some banks may allow you an interest holiday also during the moratorium period. However, the interest will be compounded and your EMI may increase significantly as we saw in the example above.
Tax Benefit on Home Loan
You can avail tax benefits on the interest paid during construction under section 24 of IT Act. For more details, read – Home Loan Tax Benefit.
Now, is moratorium period good or bad for you? Well, the simple answer is that it depends on your situation.
- If you have the capacity to pay, you should start paying your EMI as soon as possible.
- However, if your finances are tight at the moment, moratorium period can act as a great breather.
In some cases, your bank may insist that you have to compulsorily opt for moratorium period. In that case, you can deposit the extra amount either in a Fixed Deposit or a Recurring Deposit and once your moratorium period is over, you can pre-pay your loan with the accumulated amount.
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