What is EMI?

Have you ever wondered what goes into your monthly loan payment or how it’s calculated? When considering a loan, one of the key factors that borrowers need to understand is the EMI or Equated Monthly Installment. If so, you’re not alone. Understanding EMI can be crucial in managing your finances effectively. This article will guide you through what EMI is, how to calculate it, and the factors influencing it, making the process of loan repayment clearer and more manageable for you.

EMI Meaning

EMI, short for Equated Monthly Installment, is a fixed amount paid by a borrower to a lender on a monthly basis. The EMI includes both the principal amount and the interest charged on the loan. This system helps borrowers repay their loans in manageable monthly installments over a specified period. Whether it’s a home loan, car loan, or personal loan, the concept of EMI remains the same.

Understanding EMI Calculation

The calculation of EMI involves a straightforward formula that helps determine the fixed monthly amount you need to pay. The formula is:

EMI = P x r x (1+r)n(1+r)n – 1

Where:

• The principal amount of the loan is P.
• The monthly interest rate is expressed as r, which is the yearly interest rate represented as a decimal divided by 12. 
• n is the number of monthly installments or loan tenure in months.

Example Calculation:

Let’s break down an example to see how this works in practice.

Suppose you have taken a loan of ₹10,00,000 to build a house. The bank offers you a home loan at an annual interest rate of 7.2% for a tenure of 10 years. To calculate the EMI:

1. Convert Annual Interest Rate to Monthly Rate: Monthly rate = 7.2%12 = 0.6% 
2. Number of Months (Tenure): 10 years = 120 months.
3. Substitute Values into the Formula: EMI = 10,00,000 X 0.006 X (1 + 0.006)120(1 + 0.006)120 + 1

Solving this gives an EMI of ₹11,714. Thus, you would pay ₹11,714 every month for 10 years. Over the entire period, the total amount paid would be ₹14,05,702, where ₹4,05,702 is the total interest charged.

Understanding Your EMIs with an Amortisation Schedule

To grasp the concept of EMIs fully, it’s important to understand the loan amortisation schedule. Each EMI payment consists of two parts: one portion covers the interest charges, and the remaining amount reduces the principal balance. Initially, a larger portion of your EMI goes towards interest, but over time, more of your payment applies to the principal. The amortisation schedule provides a clear breakdown of these changes, showing how much of each EMI goes towards interest and principal.

For example, if you buy a smartphone for ₹1,00,000 and choose to pay via EMIs, you might end up paying around ₹17,254.84 per month over six months. In the first month, ₹1,000 of your payment covers the interest, while ₹16,254.84 reduces the principal. The principle component grows while the interest portion lowers as long as you keep up your payments. Your last EMI completely pays the debt by the sixth month.

Advantages of EMIs

EMIs provide several benefits, making large purchases more manageable for individuals. Here are some key advantages of EMIs:

• Eases financial pressure: EMIs break down large expenses into smaller, regular payments, helping spread the cost over time and making it easier to manage finances. 
• Improves affordability: Expensive purchases, such as homes, vehicles, or electronics, become more attainable without depleting your savings by offering a flexible payment structure. 
• Helps build credit history: Consistently paying EMIs on time can boost your credit score, creating opportunities for better financial products in the future. 
• Access to better interest rates: A higher credit score, improved through timely EMI payments, may lead to loans at more favourable interest rates. 
• Predictable payments: EMIs provide a clear, structured repayment plan, promoting financial discipline and making it easier to plan monthly budgets. 
• Inclusive financing: EMIs enable more people to afford essential assets and products, fostering greater access to financial resources.

Factors Affecting EMI Amount

Several factors can influence the EMI amount on a loan:

1. Loan Amount, Interest Rate, and Repayment Tenure:

A higher loan amount or interest rate results in a higher EMI. Conversely, extending the repayment period can reduce the EMI, though it increases the total interest paid over time.

1. Fixed vs Floating Interest Rates:
   • Fixed Rates: EMI remains constant throughout the loan tenure.
   • Floating Rates: EMI can vary based on changes in the base rate, such as the MCLR (Marginal Cost of Funds Based Lending Rate) set by banks.
2. Pre-payment or Foreclosure:
   • Pre-paying a loan or foreclosing it before the end of the tenure can reduce the total EMI burden. However, banks might charge additional fees or penalties for early repayment.
3. Down Payment:
   • Increasing the down payment decreases the principal loan amount, which lowers the interest rate.
4. Compound Interest:
   • If the loan uses compound interest, the EMI amount can vary based on how frequently interest is compounded. Compound interest means you pay interest on the interest accrued, which can impact the total EMI amount.
5. Missed Payments:
   • Failure to make timely EMI payments can lead to penalties and additional interest charges, which can increase the total cost of the loan.

Conclusion

Understanding EMI is essential for anyone taking out a loan. It simplifies the repayment process and helps you manage your finances effectively. You may guarantee that you can easily manage your loan repayments and make educated borrowing decisions by learning how to calculate effective monthly interest (EMI) and the factors that influence it. If you’re considering a loan, use the Angel One EMI calculator to estimate your payments and plan your finances accordingly.

FAQs