Everything you need to know about EMI and how to calculate it
Well, what is EMI? Equated Monthly Instalments (EMIs) are monthly payments made toward a loan. The principal and the interest are the two parts of an EMI. The loan’s principal is subtracted from the amount you borrow. Lenders require interest payments because they incur expenses while making loans. The original principal and the remaining principal balance are subject to this interest charge.
What is Loan EMI Calculation?
Let’s start with a basic definition of EMI. Equated Monthly Installment (EMI) refers to payments equal to each month. The terms “equal in value,” “monthly,” and “instalment” all refer to the frequency at which payment is expected.
The phrase “Equated Monthly Installment” (EMI) refers to the fixed monthly payment that a borrower makes to a lender over a certain period.
The monthly instalment is determined by the loan amount, term, and interest rate. The number of loan EMIs and the number of payments are inversely related.
EMI Interest Rate
Interest rates are another major component in determining the magnitude of EMIs. Rates of interest are variable from one creditor to the next. The market circumstances at the time of the loan are considered, along with the borrower’s ability to repay the loan based on their income, savings, and credit history.
Interest rate selection is a significant factor. When it comes to the many forms of interest, there are:
Reducing Rate
The reducing rate decreases as the principal is repaid. Interest is computed on the total outstanding balance, and the interest rate decreases as the principal balance decreases.
Floating Rates
Interest rates, loan terms, and monthly instalments on “floating” loans are all subject to change based on factors like the national economy. The Reserve Bank of India (RBI) executes interest rate modifications once every three months. Using a floating rate is OK if the base rate is not altered. Of course, they can also be erratic at times. They should be avoided at all costs.
Fixed Interest Rates
Loans with fixed interest rates have their interest rate and term determined at the time of borrowing the money, and they do not fluctuate over the loan’s duration. Fixed interest rates often run 1-2% higher than those that are variable. This is the method of choice because it provides a ballpark estimate of the monthly instalment fee.
Progressive EMI
Progressive EMIs are EMIs where the payment amount rises after a certain amount of time. This facilitates a quicker payoff of the debt.
No Cost EMI
It’s remarkable how quickly a sale may be converted on an e-commerce website or app by mentioning no-cost EMIs. You may now use your credit or debit card to make a purchase using the No Interest EMI options.
It would be a shock to hear that the RBI regulations do not allow for interest-free or zero-interest monthly payments (EMI). These EMIs often have substantially higher interest rates than the alternatives. A substantial processing charge is added to the EMIs or the reduced amount on the MRP is included. The ‘no cost’ assertion is, at best, misleading.
Equated Monthly Installment (EMI): How Does It Operate?
Two methods exist for determining the EMI. The items in question are:
- Flat Rate Method
This calculation approach includes the principal and interest accrued on the principal in the final total. This figure is multiplied by 12 since that is how many months there are in a year after dividing the total by the loan’s maturity date.
Payment Plan with a Flat Rate EMI
Let’s pretend you’ve gotten a mortgage for 10, 00,000 (the principal loan amount) at an interest rate of 8% for 10 years. The following is the formula for determining your EMI based on the flat rate method:
(₹10, 00,000 + (₹10, 00,000 x 10 x 0.08)) / (10 x 12)
The monthly instalment is 15,000.
- Reducing Balance Method
Using the reducing balance approach, EMI may be computed with the following formula:
(P x I) x ((1 + r)n)/ (t x ((1 + r)n)- 1)
This is an example expression using P, I, r, n, and t, where P is the loan principal, I is the yearly interest rate, 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.
Reduced-Balance Example EMI
Using the same example, the EMI may be computed using the reducing balance approach.
((₹10, 00,000 x (0.08)) x (1 + (0.08 / 12)) 120) / (12 x (1 + (0.08/12)) 120 – 1).
There will be a monthly payment of 12,133.
The declining balance technique of calculating EMIs results in less payment than the flat rate approach. While calculating the EMI flat rate, the loan’s principal is kept at a fixed amount for the duration of the loan. Alternatively, the declining balance technique uses the monthly principal reduction to determine the EMI. This indicates that paying down the debt can save borrowers money.
Bottomline
You can now say, “It’s so easy!”
It would be best if you now had a firm grasp on what an EMI is, what goes into an EMI, and how to calculate an EMI for a loan using Excel and a web-based calculator.
You should also be aware that the EMI amount may change even if the underlying circumstances remain the same.
Possible causes include the use of a flat-rate or reducing-balance system of computation. With this information, you can confidently compare EMI plans and select the one that best suits your financial situation.