What is EMI? How is it calculated? - MoneyTap
What is EMI
What is EMI? How is it calculated?
Shiv Nanda
Feb 17 • 5 mins read

What is EMI? How is it calculated?

5 mins read

Loans are an integral part of our lives today. We take loans for a specific purpose – be it for buying a home, a car, or sending kids abroad for education – loans help us achieve some very important life goals. That said, when we talk about loans, the word “EMI,’ eventually crops up because the amount we borrow has to be returned to the lender with interest.

Let’s understand what is EMI and how does EMI work.

What is an EMI (Equated Monthly Installment)?

EMI is defined as the payment amount made by a borrower to a lender at a specified date each calendar month.

What Factors Affect EMI?

The factors affecting an EMI are as follows

  • Principal borrowed: This is the total loan amount borrowed by the individual.
  • Rate of interest: This is the interest rate charged on the borrowed amount.
  • Tenure of the loan: This is the loan repayment timeframe agreed between the borrower and the lender.
  • Fixed or floating type of loan: If the interest rate is floating, the ‘Rest’ component affects the EMI.

Note: In a fixed type of loan, the EMI amount remains the same throughout the loan tenure. But, in the floating type, the EMI amount may fluctuate as and when the interest rate changes.

What is the amortization schedule?

The amortization schedule is a comprehensive table that outlines the complete loan details and the breakup of the EMI payments. It shows you how much of each EMI amount goes towards paying the principal and interest until you pay off the loan.

The amortization schedule helps you understand how your loan progresses over the loan tenure and includes details such as:

  • EMI amount
  • Principal borrowed
  • Interest cost of each EMI payment

How does an EMI (Equated Monthly Installment) Work?

There are two ways of calculating the EMI. They are:

1. Flat Rate Method

In this method, the principal loan amount and the interest on the principal are added. The sum is then divided by the loan tenure, then multiplied by the number of months in a year.

Example of Flat Rate EMI

Assume you have a home loan of ₹10, 00,000, which is the principal loan amount, at an interest rate of 8% for 10 years. Your EMI using the flat-rate method is calculated as follows:

(₹10, 00,000 + (₹10, 00,000 x 10 x 0.08)) / (10 x 12)

The EMI amount is ₹15,000

 2. Reducing Balance Method

The formula to calculate EMI using the reducing balance method is as follows:

(P x I) x ((1 + r)n)/ (t x ((1 + r)n)- 1)

P is the principal amount borrowed, I is the interest rate (annual), r is the periodic monthly interest rate, n is the total number of monthly payments, and t is the number of months in a year.

Example of Reducing Balance EMI

Let’s keep the same example for calculating the EMI using the reducing balance method.

((₹10, 00,000 x (0.08)) x (1 + (0.08 / 12)) 120) / (12 x (1 + (0.08/12)) 120 – 1).

The EMI amount is ₹12,133

Note: The EMI amount in reducing balance is lower than in the flat rate method. In the EMI flat rate calculation, the principal loan amount is constant throughout the loan tenure. On the other hand, in the reducing balance method, the EMI is calculated on the monthly reduced principal. This suggests that reducing balance may be a more cost-friendly option for borrowers.

What Are The Different Types of Loan Interest Rates?

There are two types of interest rates

  1. Fixed interest rate

    In this type, the interest rate stays the same throughout the tenure of the loan. Hence, the EMI remains the same. Typically, fixed interest rates are 1% to 2% higher than floating interest rates. Since the interest rate does not change, the benefit of a fixed interest rate is that you have a clear idea about your future EMIs until your loan is paid off.

  2. Floating or variable interest rate

    In this type, the interest rate is subject to change depending on the market trends. Since the floating interest rate is based on the base rate offered by the lending institutions, it changes automatically when the base rate changes.

Fixed interest rate or floating interest rate? Which one is better?

Fixed interest rate keeps your EMI amount the same throughout the loan tenure. So, if you don’t want to take the risk of increasing interest rates and want a sense of certainty about your monthly payments, then a fixed interest rate is the best for you.

However, if your loan is for the long-term, say 20 to 30 years, choosing a floating interest rate is advisable. Also, when you know that the base rate is going to remain constant or even get lower over a period, it makes sense to choose a floating rate. You can then plan your prepayments and reduce the interest on the loan. This means a lot of savings.

Does EMI Change During the Loan Tenure?

Your EMI is calculated based on factors such as loan amount, tenure and interest rate.

The EMI you pay may vary over the course of the loan tenure under certain circumstances, such as:

  • Loan Prepayment: Some banks allow you to prepay a portion of your loan amount as a lump sum, much ahead of your scheduled payment. If you prepay a part of your loan amount, your principal amount decreases, thus lowering your interest amount and reducing the EMI amount payable.
  • Floating interest rate: In fixed interest rate loans, the EMI amount remains unchanged. However, if you have opted for a floating interest rate, the interest rate changes as per the market conditions, thus changing the EMI amount payable.
  • Progressive EMIs: Some banks and lending institutions give you the choice of making progressive EMIs. Here, you have to pay a fixed EMI for a specified period of time and later, the payment amount increases. This type of facility is usually applicable for long-term loans.

What is an EMI calculator?

An EMI calculator is an online tool that calculates your EMI amount and compares EMIs for different loans and tenures. The calculation is based on three factors: loan tenure, interest rate and loan amount.

Features and benefits of an EMI Calculator include

  • It calculates the EMI amount you need to pay every month in seconds.
  • Once you know the EMI amount, you can plan your budget accordingly.
  • You get to know the total amount you need to pay and how much interest is charged.
  • It helps you to figure out the best loan tenure for you.

FAQs

    • What does EMI stand for?

      EMI stands for equated monthly installment.

    • What is the difference between EMI and loan?

      A loan is the amount of money that a bank or lending institution lends to you. In return, you sign an agreement with them stating that you will repay the borrowed amount with interest. EMI is the monthly installment you pay towards your loan at a specified interest rate over a specified loan tenure.

    • Is EMI good or bad?

      EMI is inherently neither good nor bad. EMI provides you with the convenience of repaying the loan in comfortable and easy installments. However, you cannot ignore the fact that through EMIs, you are actually paying more than you borrowed. The costs such as interest and processing fees are added to it. Additionally, if you default on your EMIs, it will harm your credit score, and you will have to pay penalties or an increased interest rate.

      EMI facility is beneficial as long as you make timely repayments every month throughout the tenure of the loan while also enjoying the tax benefits.

    • Is GST applicable on personal loan EMI?

      No, GST is not applicable on the loan repayment nor the interest paid on loan. However, GST is applicable on the processing fee and the other charges applied by your lender.

    • What happens if I fail to pay the EMI on time?

      If you fail to pay your EMI on time, it might hurt your credit score. Moreover, you are not considered a defaulter if you miss your EMI once. Banks issue reminders if you miss the EMIs three consecutive times. If you don’t respond to the reminders, banks levy late penalty charges and may send you a notice.

    • What is no cost EMI?

      A ‘No Cost EMI’ is a type of EMI where you do not pay interest on the principal. The loan is divided by the length of the loan tenure. This facility is usually offered by retailers/online retailers or marketplaces.

    • What are minor and major defaults?

      If you pay your missed EMI within 90 days, it’s considered a minor default. However, if you fail to make payments in the last 90 days or beyond, it’s considered a major default and your loan account is classified as non-performing assets (NPAs).

Add a comment

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Experience MoneyTap Power

Apply now

Find our social channels

© 2022 MWYN Tech Private Limited. All rights reserved

<a href="" class="copy-click"
  data-copy-string="#ITN12345"
  data-tooltip-text="Click to copy"
  data-tooltip-text-copied="✔ Copied to clipboard">
  Text to display