Equated monthly instalments, or EMIs, are a convenient way to buy big-ticket items, such as a car or a house. Here’s an essential primer.
EMIs, short for equated monthly instalments, is no alien term in today’s world. Want to buy a house? Get a home loan and pay it back through EMIs. Need a car? A car loan will help, and you can pay it back through EMIs. Think of a loan, and EMIs are the default option to pay it back. At a more fundamental level, EMIs help you buy stuff that you might not be able to if you had to pay for it upfront. Let’s understand EMIs in greater detail and understand their various aspects.
What Is an EMI?
EMI stands for ‘equated monthly instalment’. It is the monthly amount you must pay your lender to repay a loan or debt, such as a home loan, a car loan, a personal loan, etc. EMI is a popular repayment method, as it allows you to purchase expensive things and pay for them in easy instalments. For example, if you want to buy a new car and you do not have sufficient funds, you can take a car loan and pay it back via EMIs. You will just need to make a down payment, which is a lump sum that goes out of your own pocket upfront.
How Do EMIs Work?
When you take a loan, your lender calculates interest for the entire loan period. Then, your loan amount and interest are divided into EMIs, which you must pay on a fixed date. These EMIs include both the interest as well as the principal portions. They remain constant throughout the loan period. An EMI is closed after the payment of the last instalment, and you can collect a NOC (no objection certificate) from the lender.
You also have other options to reduce or close your EMIs. You can prepay your total outstanding loan amount. But remember, your lender may charge pre-closure and other charges for early loan closure. Also, you can reduce your EMI by partially repaying your loan if your lender allows it. Alternatively, you can transfer your loan to other lenders offering lower interest rates. This will help you reduce your EMIs.
EMI Components
Your EMI consists of two components: principal and interest.
Principal component: It is the repayment towards your original loan amount. In every EMI payment, some portion goes to principal repayment, which reduces your outstanding loan amount with subsequent EMIs.
Interest component: It is the repayment of interest in every instalment. Interest is calculated on the outstanding loan amount for each month and included in your EMI.
In the initial period, the maximum portion of an EMI is interest. Later, principal repayment increases and the interest portion decreases correspondingly.
Factors Affecting EMIs
A number of factors affect your EMIs, such as the loan amount, interest rate, loan tenure, credit score, etc. Let’s understand each of these factors.
Principal: It is the amount you have borrowed from the financial institution. Your EMI and the principal amount are directly related to each other. The higher the loan amount, the higher the EMI and vice versa.
Interest: It is the rate at which you have borrowed the money. Interest and EMIs are directly related to each other. If your interest rate is high, the EMI amount will be high as well and vice-versa.
Tenure: It is the period in which you must repay your loan completely. It is inversely related to your EMIs. The higher the loan tenure, the lower your EMI will be and vice-versa.
Credit score: It is a three-digit number that indicates your creditworthiness to the lender. If your credit score is not good, then there are chances that you will be offered a loan at a higher interest rate, which will result in a higher EMI. So, it is advisable to maintain a healthy credit score to get the best loan offer. Generally, a credit score above 750 is considered good.
How Is an EMI Calculated?
You can calculate your EMI in two ways: the fixed-rate method and the reducing-balance method.
Fixed-Rate Method
Under the fixed-rate method, the interest amount remains unchanged over the complete loan duration. It means your monthly repayment towards principal and interest will remain the same throughout the loan tenure, irrespective of the amount repaid in instalments.
In this method, the total interest is computed for the initial borrowed amount. Then, the total interest and principal are paid in equal monthly instalments over the loan period.
You can calculate your EMI by using the following formula:
((P x R x N) + P )) / (N x 12)
Where,
P is the amount borrowed,
R is the interest rate
N is the loan tenure
Let’s take an example to understand this formula:
Let’s say you borrowed Rs. 2 lakh at a fixed interest rate of 12% for two years. Your monthly EMI will be calculated as
((2,00,000 x 12% x 2) + 2,00,000)) / (2 x 12)
After calculation, your monthly EMI will be Rs. 10,333.
Reducing-Balance Method
Under the reducing-balance method, interest is computed on the principal balance remaining after each payment. Your EMI includes both interest and principal components. Thus, your principal balance is reduced after each repayment. Next time, when you pay another instalment, interest is again computed on the reduced balance only. This process goes on for the full loan tenure.
As interest is computed on the outstanding principal balance, initial instalments include a higher proportion of interest and a lower proportion of principal repayments. In later years, the proportion of principal increases, and the interest proportion decreases in your EMI.
You can calculate your monthly EMI by using this mathematical formula:
P x R x (1+R)^N/[(1+R) ^ (N-1)]
Where
P is the amount borrowed,
R is the per-month interest rate (for example, if the annual interest rate is 18%, then monthly interest will be 1.5% (18% / 12)).
N is the loan period in months.
Let’s understand this formula with an example.
Assume you have borrowed Rs. 5 Lakh at 18% for 10 years. In this case, P will be Rs. 5 lakh, R will be 1.5% (18% / 12), and N will be 60 (5 x 12).
Let’s put these values in the formula: 5,00,000 x 1.5% x (1+1.5%)^60 / [(1+1.5%) ^ (60-1)].
After solving the equation, your monthly EMI comes out to be Rs. 12,697. Your total repayment over five years for this loan will be Rs. 7,61,803, and the total interest will be Rs. 2,62,803.
Calculating your monthly EMI using a mathematical formula could be complicated and time-consuming. Hence, alternatively, you can use ET Money’s EMI calculator to calculate EMI in simple steps.
You just have to enter the loan amount, interest rate and loan tenure and click on the calculate button.
Advantages of EMIs
EMIs help you repay your loan in small instalments, but there are other advantages too. These are:
- One can use EMIs to buy high-value things that one may otherwise be unable to.
- As the EMI amount is fixed, you can plan your monthly budget accordingly.
- EMIs help you opt for the most suitable loan tenure.
- They can also help you improve your credit score if you make your EMI payments timely.
Types of EMI Loans
There are different types of loans you can repay through EMIs i.e Secured and Unsecured Loan which is further divided into personal loan, home loan, car loan, etc. Let’s understand each of these in detail:
Personal loan: A personal loan is an unsecured loan taken for short-term expenses, such as family vacations, home improvement, medical emergencies, etc. Unlike a secured loan, such as a car or home loan, a personal loan does not require collateral. These loans are generally offered at higher rates. You can use the Personal Loan EMI calculator to calculate your EMI on the personal loan and choose the best loan offer.
Home loan: A home loan is taken to buy a house. As such loans are secured, the interest rate is lower than that for personal loans. Generally, home loans have a longer tenure (10 to 30 years) of repayment.
It is desirable to check your EMI before proceeding further with your loan application. You can calculate your home-loan EMI using a home-loan EMI calculator.
Car loan: A car loan is also a secured loan taken to buy a car, where the car itself is the collateral. Hence, in the event of non-repayment, the lender can requisition the car.
When purchasing a car, it is necessary to provide a portion of the total cost upfront as the down payment. The remaining amount can be borrowed from a bank as a loan and can be repaid in EMI. You can calculate your car loan by using a car loan calculator.
Frequently Asked Questions
What is EMI per month?
EMI is the fixed monthly payment that you have to make for a loan availed, such as a home loan, a car loan or a personal loan. It is calculated based on the loan amount, interest rate, and loan tenure. For example, if you take a loan of Rs. 10 lakh for 10 years at a rate of 14%, then your EMI will be Rs.15,527.
How much EMI is safe?
A safe EMI amount depends on multiple factors, such as your income, existing debts, current expenses, and other financial goals. But generally, to be on the safer side, the total EMI should not exceed one-third or 33% of your total monthly income.
Is an EMI good or bad?
EMIs can be both good and bad. It depends on your requirements and financial situation. EMIs enable you to buy big-ticket items without paying the full amount at the time of purchase. In this sense, they are good. However, they can be bad if you take on more debt than you can comfortably repay. The burden of EMIs can severely impact your life if you are not judicious with them.
Are EMIs interest-free?
No, EMIs are not interest-free. You pay a fixed amount to the lender for loan repayment, which includes both principal and interest components.
Can EMIs be refunded?
Your EMI amount cannot be refunded. But if there are any technical issues and your account has been debited twice, your lender can refund or adjust your EMI against your subsequent EMIs.
What are EMI return charges?
Paying your EMIs on the due date is important, as it improves your credit score. Defaulting on your EMI can result in a penalty called EMI return charges. This penalty varies from lender to lender. You can check your loan sanction letter to know about your lender’s EMI return charges.
What is the formula used in calculating EMI on loans?
You can calculate your EMI on loans using the formula, P x R x (1+R)^N / [(1+R) ^ (N-1)]
Where P is the principal amount borrowed, R is the interest rate, and T is the loan period.
