Thread by @deepakshenoy

How does the interest on interest work? (Thread)

Lets say your loan was Rs. 40L, and your EMI was Rs. 40,000. If there's a moratorium, and you don't pay anything, your principal will go UP every month based on unpaid interest. So month 1 it might go up to Rs. 40.3 L (assuming 30K interest)

month 2 it will then go to 40.62L.

In Month 2, you're paying interest on the original 40L balance before the moratorium plus the additional balance due to interest in Month 1.

The judges seem to say this:
a) Pay interest on original 40L, yes.
b) Maybe shouldn't pay additional interest on intermediate interest

This is a huge come-down from the original stance, so the hit to banks is much lesser even if the judges decide to implement no interest on interest. But how will that work?

Here's a way.

Add all the interest for the moratorium period to the principal at the end of 6 months. (the moratorium is for 6 months)

If you have the money, pay up the bunched interest at the end of 6 months. If not, it gets added to principal and then your EMI will extend for longer.

In the current situation (interest is there, and then further interest on that interest is there), a 10 year loan will stretch to 11 years 2 months.

Bunch up the interest for 6 months with no compounding and there's no difference (will still stretch to 11 years 2 months)

That means the court's not really going to change much for banks if they say "no interest on interest for 6 months". Because after 6 months, the interest on interest has to apply.

So in effect, their stance essentially helps banks.

And no, tenure doesn't really matter. A 1 year loan stretches to 18 months even if you don't do interest on interest (and add to principal after 6 months instead).

If you have a loan AND have the money, please pay. The moratorium will make you pay a lot more eventually.