What Is EMI And How Is It Calculated?
Posted on Wednesday, February 28th, 2018 | By IndusInd Bank
With heightened rates of inflation and a constant increase in daily expenses, it has become more difficult today to make substantial purchases without disrupting the household budget. In this scenario, loans enable us to go ahead and buy what we want, and help us fulfil our dreams. Today, a wide range of products such as home loans, car loans, personal loans, two-wheeler loans, etc. are readily available to us and have become extremely popular ways of funding our requirements.
Getting a loan is now easier than ever, but if you are looking to optimize your resources and get the most out of your money, you must study the basics and understand the essentials of borrowings before deciding to take a loan.
The most important factor associated with a loan is the repayment process. A loan must be repaid in fixed instalments, called Equated Monthly Instalments (EMIs), over a certain period of time. So when you take a loan from a financial institution or a bank, you must pay a fixed amount of money to them every month as the repayment towards the loan taken. This monthly payment is known as an EMI and must be paid till the time the loan is fully repaid. It is a feature of loans whereby you may raise funds for immediate use in the present and repay the amount at your convenience over an extended period of time.
The value of an EMI varies according to your convenience and is based on three factors-
• The amount of loan that you wish to take
• The interest rate charged on the loan
• The period or tenure for which the loan has been availed
The two main components of an EMI are the principal amount and the interest, where the latter is charged on the former and the total is spread out over each month of the loan duration. While the interest component accounts for a larger chunk of the EMI during the initial stages, the contribution towards repaying the principal loan amount is what constitutes a major portion of the EMI as the tenure progresses. Basically, with the maturity of the loan, the principal amount keeps coming down with every payment and the outstanding amount due to the bank reduces. The interest that is attracted by this outstanding amount decreases correspondingly.
With this in mind, you could reduce the cost of your loan significantly by keeping track of your EMIs and studying how the loan is being paid. A great way to keep track is by using a loan amortization schedule. It is a simple tabular presentation of your loan, which shows the EMI payments made by you and breaks down each payment into the principal and interest components respectively. It gives you all the information regarding the outstanding loan amount, time period of each payment, the interest and principal amount to be repaid. You could use this information wisely to refinance your loan or opt for pre-closure. If you wish to opt for prepayment of your loan, it is advisable to do it in the early part of your loan tenure. This way the principal amount decreases and you save on paying interest later on.
The EMI feature makes taking a loan very appealing as it allows you to plan monthly payments and choose a loan amount according to your resources. Monthly EMIs would be higher over a shorter tenure and decrease as the tenure is extended. Accordingly, you may choose the repayment scheme that suits you.
Before you choose your plan, it might also be prudent to understand how to calculate the EMI for your loan. A simple mathematical formula is used to calculate this EMI. This is –
EMI = P x R x (1+R)n/ (1+R)n-1
P is the Principal Amount,
R is the Rate of Interest, and
n is the Tenure in number of months
Now if, for example, you take a car loan of INR 1 lakh at an interest rate of 10% for a period of 1 year (12 months), the EMI to be paid, using this formula, would be INR 8792.
It must be noted that the exact EMI amount might vary slightly depending on a couple of factors. Firstly, if you have opted for a floating rates loan, the interest on the loan amount is determined by prevailing market rates which could vary from time to time. Since the interest rate plays an important role in your final EMI amount, this could lead to varied payments. Secondly, if you choose to make a prepayment against your loan at any time before the loan matures, your principal amount would go down and the interest attracted on it would be reduced as well. So you could change the tenure of your loan or simply pay lesser EMIs for the same duration.