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DYK: How is an equated monthly instalment calculated

EMI amount constitutes of principal repayment and interest on the outstanding loan

Equated monthly instalments (EMIs) are an integral part of most urban families’ expenses. With easy availability of loans and repayment processes, people do not hesitate in borrowing. Moreover, paying in instalments makes it possible for us to buy big-ticket products and assets. From a mobile phone to a house, from a car to paying for education, you can borrow money for almost anything and pay back in instalments. But before you borrow money thinking that the instalments look affordable, know how various instalments, including EMIs, are calculated and what are the important factors to be considered before you borrow money.

WHAT IS AN EMI?

An EMI is typically a fixed amount that the borrower needs to pay against her borrowing to the lender every month. EMI amount constitutes of principal repayment and interest on the outstanding loan. During the initial months, interest proportion is higher. This gradually reduces with each payment and after sometime, the principal repayment amount becomes higher than the interest amount. An EMI is typically debited from the borrower’s bank account on a fixed date each month or quarter, as per the loan agreement.

THE CALCULATION

EMI is calculated based on three main factors—the amount of loan, applicable interest rate and the repayment tenure. The higher the loan amount and the applicable interest rate, the higher the amount of EMI; whereas longer the tenure of repayment, lower is the EMI. You can use online calculators, such as those available on bank or loan aggregator websites, or calculate the EMI yourself, though the formula is complex.

Using a financial calculator or Excel sheet can make your job easier. The formula to calculate your EMI is: =P x R x (1+R)^N/((1+R)^N-1). P stands for the principal or the loan you have taken from the lender. R is the interest rate applicable. If the interest rate per annum is 10%, then R will be 10/(12 x 100) for monthly instalments. And N is the number of instalments that you have to pay.

WHEN CAN AN EMI CHANGE?

Given that the amount of EMI depends on the applicable interest rate, in case of fixed interest rate loans (such as an auto loan), the instalment amount does not change. However, with a floating rate interest loan (such as a home loan), the EMIs can change.

If you make a partial prepayment, the EMI will change accordingly since this would reduce the outstanding amount. When you prepay partially, you can also choose to reduce the loan tenure instead of the EMI. So, for a home loan, you can bring down the tenure from, say, 240 months (20 years) to 228 months (19 years), while the EMI remains unchanged.

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