Most of us have to take out a home loan to buy a home. Home loans come in several varieties. One of the most popular mortgage options is the building society loan. A prominent example is the SBI Maxgain Loan product. In this post I would like to briefly explain how building loan products work and what you need to consider if you have already taken out such a loan.

## How are building society loans structured?

I’m not going to go into the details of a specific home loan product like SBI MaxGain. Just going to discuss the basic structure.

There are two types of accounts for building society loans. Note that the nomenclature may vary depending on the loan product.

1. Credit account: means your actual outstanding amount
2. Excess account: You can deposit money into this account yourself. Alternatively, any interest savings from the EMI loan are credited to this account (discussed later). You can withdraw from this account at any time (subject to certain conditions being met).

For a reduced balance loan (like your home loan), interest is charged on the principal amount outstanding each month. This monthly interest is deducted from your EMI and whatever is left is used to reduce the principal. For more information on how Credit EMI Payments work, see this post.

In the case of building society loans, the interest for the month is calculated on (loan outstanding – account surplus).

Let’s take an example.

Let’s say you take out a loan of Rs 50 lacs. Assume that the entire amount is paid out on the 1st day. The loan has a term of 20 years with an interest rate of 9% pa. Your EMI is Rs 44,986.

### How is a regular home loan repaid?

First month

Capital outstanding at the beginning of the month = Rs 50 lacs

EMI = Rs 44,986

Interest for the month = Rs 50 lacs X 9% / 12 = Rs 37,500

Capital repayment for the month = Rs 44,986 – Rs 37,500 = Rs 7,486

Outstanding Capital at End of Month = Rs 50 Lacs – Rs 7,486 = Rs 49.92,514

Second month

Capital outstanding at the beginning of the month = Rs 49.92.514

EMI = Rs 44,986

Interest for the month = Rs 49.92.514 X 9% / 12 = Rs 37.444

Capital repayment for the month = Rs 44,986 – Rs 37,444 = Rs 7,542

Principal outstanding at month end = 49.92.514 rupees – 7.542 rupees = 49.84.971 rupees

And this process continues.

## How is repayment made for the SBI Maxgain Loan or any building society loan?

Let’s say you deposited Rs 5 lacs into your OD (surplus) account on day one.

Loan Account (Outstanding Balance) = Rs 50 Lacs

Excess Account = Rs 5 Lacs

In the case of building society loans, the interest for the month is calculated on (credit account – surplus account)

First month

Principal Outstanding at Start of Month = Rs 50 Lacs (Loan Account)

Excess Account = Rs 5 Lacs

EMI = Rs 44,986

Interest for the month = (Rs 50 lacs – 5 lacs) X 9% / 12 = Rs 33,750

Capital repayment for the month = Rs 7,486 (now this corresponds to the original depreciation schedule. No change here)

You can see that EMI is not being fully used. 33,750 + 7,486 = Rs 41,236. What happens to the rest of EMI.

It will be added to your surplus account. Excess balance at the end of the month = Rs 5 lacs + Rs 3,750 = Rs 5,03,750

Outstanding Capital at End of Month = Rs 50 Lacs – Rs 7,486 = Rs 49.92,514

Second month

Fund outstanding at the beginning of the month = Rs 49.92.514 (Loan Account)

Surplus account = 5.03.750 rupees

EMI = Rs 44,986

Interest for the month = (Rs 49.93 lacs – Rs 5.03 lacs) X 9% / 12 = Rs 33,666

Capital repayment for the month = Rs 7,542 (now this corresponds to the original depreciation schedule. No change here)

Excess balance at the end of the month = 5.03 rupees + (44.986 rupees – 33.666 rupees – 3.778 rupees = 5.07.528 rupees)

Principal Amount outstanding at end of month = 49.92.514 rupees – 7.542 rupees = 49.84.971 rupees

## How do SBI Maxgain or building society loans benefit?

You can see the principal decrease according to the original amortization schedule (unless you specifically make an advance payment).

Keeping the money in the surplus account is not considered prepayment, but it does give you all the benefits of prepayment and more.

If you prepay on a regular home loan, you will lose access to the prepayment amount. It’s gone. Your outstanding credit is going down.

With home savings loans, by keeping the money in the surplus account, you reduce the outgoing interest (effectively what the prepayment would have achieved). At the same time, you do not lose access to the money. You can withdraw money from the surplus account at any time. Only when you withdraw the money will your interest for the month be calculated accordingly. Note that when you add funds to the surplus account, your outstanding loan will not go down.

Your saved interest becomes interest earned. Finally, the interest savings from the EMI are credited to your surplus account. You can withdraw from the surplus account at any time. If you had kept the money in a savings account of a fixed deposit account (instead of a surplus account), you would have received a much lower return than the interest rate on the loan. Since this is your own money (and not interest), the growth of the surplus account due to interest savings is not taxed as interest.

For these reasons, the Excess Account (or the OD Account) is a perfect destination for short-term or emergency funds.

The building society loan offers the advantages of a prepayment without affecting the liquidity or flexibility of your money.

## You should keep this in mind if you have taken out a building society loan

#1 With home savings loans, the interest saved is the interest earned. If there is no interest to be saved, no interest will be earned. If the balance of the surplus account is higher than the principal amount outstanding (loan account), the additional amount (surplus account – loan account) will not help you save interest. In the parlance of SBI Maxgain, the book balance will be positive in this situation.

Therefore, you will not receive any interest on the additional amount. So make sure that the balance of the excess account never violates the principal’s outstanding amount. Let’s say the outstanding loan is Rs 20 lacs. The excess account has Rs 25 lacs. Those extra Rs 5 lacs won’t help you with anything. Better to invest this money than fixed-term deposits.

# 2 You need to keep an eye on the credit and surplus account balances. The balance of the credit account will decrease every month according to the amortization schedule. Excess account balance will continue to grow due to interest savings added every month. The difference between the account surplus and the outstanding capital decreases automatically every month. For example, in the example shared above, the difference decreased by Rs. 11,321 in the second month.

# 3 You will not receive any tax benefits under Section 80C on the money you have held in the Overdraft Account (Overdrafts). In addition, you will not receive any Section 24 tax benefits on the interest that you have not paid (or saved).

# 4 You may have to pay a higher interest rate compared to a regular home loan product.

# 5 You opt for building society loans such as SBI MaxGain in order to remain flexible with your prepayment money. However, Certain conditions may be met before you can withdraw from the surplus account (overdraft account). For example, under SBI MaxGain, you cannot withdraw funds from the Excess Account (OD) until you have taken possession of the house. Say you have Rs 5 Lacs parked in your surplus account under SBI Maxgain, but you still have not received ownership of your home. In such a case, you will not be able to withdraw these Rs 5 lacs from the excess account. Misses the purpose of the credit structure, doesn’t it?

# 6 Before these conditions are met, depositing money into a surplus (OD) account is the same as making a prepayment as you will lose control of your money. Other such credit products may have different requirements. You need to keep this in mind. Until these conditions are met, just put the money in the surplus account that you are sure you will not need until you are expected to own the house.

### Examples of home loan products

1. SBI MaxGain
2. CitiBank home loan