[ecis2016.org] When opting for a loan for investments such as buying a home, the EMI facility proves to be highly beneficial. Here is all you need to know about EMI and how it is calculated
It is wiser to opt for a loan to meet large financial expenses, such as a wedding, home renovation or any emergency expense, rather than depleting your hard-earned savings. Applying for a loan from a bank or lending institution, also brings you the convenience of repaying it over a period of time via regular installments, known as equated monthly installments (EMIs). For example, buying a home involves significant investment and opting for a home loan, gives you the advantage of not just availing of various tax benefits but also the flexibility of paying EMIs.
You are reading: What is EMI and how is it calculated?
In an age of rising inflation, the facility of EMIs allows you to remain stress-free, as it eliminates the burden of making lump-sum payments for large purchases and instead, eases things by letting you know the exact amount to be paid regularly without burning a hole in your pocket.
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What is an EMI?
An equated monthly installment (EMI) refers to the fixed amount of money that you pay to a bank or lender, as part of the repayment towards an outstanding loan within a specified time period.
Simply put, EMI is a facility that banks and other financial institutions provide to their customers, to borrow the loan amount for fulfilling immediate cash flow needs and then, allow them to repay it in installments at a specific rate of interest over a defined loan term. The customer is required to make these payments on a specified date every calendar month. One can pay the EMI amount through cheque or choose an online mode like the auto-debit facility.
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Components of EMI
An EMI has two components – principal repayment and interest. During the initial years, a significant portion of the EMI consists of the interest amount. However, towards the end of loan tenure, the principal amount constitutes a major part of the EMI payment and the interest cost forms a comparatively lower amount.
What is the amortization schedule?
The amortization schedule refers to a comprehensive table that shows the complete loan details, with a breakup of the EMI payments. It lists down the principal and interest amount for each payment. This schedule helps in understanding how the loan progresses over the course of its tenure.
The amortization table will include details such as the scheduled payments, the principal borrowed and the interest expense of each scheduled payment. It helps to understand how the loan works and also to know the interest-related details for claiming tax benefits.
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How is EMI calculated?
The EMI is calculated based on the following mathematical formula:
EMI = P × r × (1 + r) ^ n / ((1 + r) ^ n – 1)
Where,
P = Loan amount.
r = Rate of interest, which is calculated on a monthly basis.
n = Loan tenure (in months).
Let us understand by taking the following example:
Vinay has taken a loan of principal amount Rs 5 lakhs at an interest rate of 12% and a loan tenure of three years. The EMI will be calculated based on the formula mentioned above.
| Principal amount (in Rs) | 5 lakhs |
| Interest rate (%) | 12% |
| Tenure (in months) | 36 |
| EMI payable (in Rs) | 16,607 |
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Factors that affect EMI
Here are the major factors that impact the EMI:
- Principal loan amount: It is the original loan amount that an individual borrows from the bank or lender. It is the foremost factor, based on which the EMI amount is decided. If the principal amount is higher, the EMI will increase.
- Rate of interest: It refers to the interest rate that banks or financial institutions charge for loan repayment. The rate is arrived at, based on various calculations and assessment of the borrower’s credit profile.
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- Loan tenure: The tenure of the loan refers to the period within which the entire loan, including the interest, has to be repaid by the borrower. If the tenure is longer, it implies that you will have to pay more interest to the bank or lender.
What are the types of loan interest rates?
Loan interest rates are of the following types:
- Fixed interest rate: Here, the interest rate remains unchanged throughout the loan tenure. Hence, the loan EMI remains the same. Usually, fixed interest rates are higher than current floating interest rates by 1% to 2%. However, since the interest rate does not vary, you will have a clear idea about your future EMI payments.
- Floating or variable interest rate: In the case of floating interest rates, the interest rate will be subject to change, depending on the market trends. It is based on the base rate offered by the lending institution. Thus, the interest rates automatically change if the base rate varies.
Should you opt for a fixed interest rate or floating interest rate?
Since fixed interest rates keep you relaxed about the EMI payments, the amount of which remains constant, you can opt for it as it will give you a sense of certainty about your payments, especially if you do not want to take risks of increasing interest rates. Ideally, it is suitable if the loan term is between three to 10 years.
However, opting for a floating interest rate is advisable, if it is a long-term loan of 20 or 30 years. Choose a floating interest rate when you know that the base rate will remain constant or low over a period. You can plan for prepayments and reduce the total interest on your loan, thereby, saving a lot.
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Does EMI change during the loan tenure?
The equated monthly installment or EMI is calculated based on factors, such as loan amount, interest rate and tenure. However, the amount you need to pay as EMI may vary during the course of the loan tenure, depending on certain conditions.
We discuss them below:
- Floating interest rate: In the case of fixed-rate loans, the EMI amount remains the same. However, if one opts for a floating interest rate, the interest rate will be subject to change, as the floating interest rate changes as per the market scenario. Hence, it will impact the EMI payable by you.
- Prepayment of loan: Many banks allow the facility of prepaying a portion of one’s loan amount as a lump-sum, ahead of the schedule. By prepaying the loan amount, the principal amount will decrease, thus, reducing the EMI amount payable. Prepayment enables a person to save on interest.
- Progressive EMIs: Some lending institutions allow the choice of progressive EMIs for repaying the loan amount. One is required to pay a fixed EMI for a specified period, after which the amount subsequently increases. It is usually applicable in the case of long-term loans.
What is an EMI calculator?
An EMI calculator is a digital tool that computes the equated monthly installment, i.e., EMI amount you have to pay, based on the details you enter, such as loan tenure, interest rate and loan amount. The tool enables borrowers to know the actual EMI amount payable every month. There are various types of EMI calculators, such as personal loan EMI calculator, EMI calculator for home loan, education loan EMI calculator, to name a few.
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Benefits of using an EMI calculator:
- Financial planning: The online EMI calculator is useful, as it enables you to understand your monthly outgo and eases your financial planning towards other investments.
- Accuracy: Since the calculations are computerised, you can rest assured that the results are accurate and you get an exact figure of the amount needed to pay to the lender.
- Accessible: There are no hassles of visiting a bank, as this online calculator is a handy tool that can be accessed at your comfort, anywhere and anytime.
- Time-saving: While it replaces the need for manual calculations, the online EMI calculator enables you to get instant results about how much your loan will cost, thus, saving time.
- Ease of comparison: You have the advantage of comparing different loan offers. By entering the required loan amount and tenure options, you can try various combinations and compare the results, for making an informed decision.
FAQs
What is full form of EMI?
EMI stands for equated monthly installment.
Is EMI good or bad?
While the EMI option provides the convenience of repaying the loan in installments, you should not overlook the fact that you may be paying more than the actual value of the product. There are additional costs in the form of interest and processing fees. Moreover, if you default on the EMI payment, it may impact your credit score and you may have to bear additional charges or increased interest rates. However, when it comes to long-term financial decisions like buying a home, getting a loan with an EMI facility is highly beneficial, as you can repay the amount through timely payments conveniently over a period of time while also enjoying tax benefits.
What is the difference between EMI and loan?
A loan refers to the amount of money that a bank or financial institution lends to a borrower in return for an agreement that the borrower will repay the amount with interest. EMI refers to the transactional method, based on which the borrower repays the loan as periodic payments at a specified interest rate over a specified period.
Is GST applicable on personal loan EMI?
GST is not applicable on the loan repayment amount or interest on the loan. However, GST will be applicable on the processing fee and other charges levied by your lender.
What happens if EMI is not paid on time?
If the EMI is not paid on time, it can impact the credit score of the borrower. Normally, banks do not consider a customer as a defaulter if he or she misses EMI payment once and will send reminders if the customer misses it three consecutive times. Banks issue late penalty charges and may issue notice, if the customer does not respond to the reminders.
What are minor and major defaults?
EMI payments made within 90 days are considered minor defaults while payments in the last 90 days or beyond are regarded as major defaults. Such loan accounts are classified as non-performing assets (NPAs).
What is no cost EMI?
A ‘No Cost EMI’ refers to a loan, where you do not have to pay additional interest on the principal. This is generally offered by retailers/ online marketplaces for relatively small ticket purchases such as consumer durables, electronics, etc.
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