What Is EMI And How Is It Calculated?
You must pay an equivalent monthly instalment or EMI to take out any retail loan a lending institution offers. Nevertheless, figuring out how much you can afford can be challenging.
Borrowers can estimate their monthly payments with an EMI calculator based on the principal amount, interest rate, length of the loan, and other variables.
Formula to Calculate EMI on Loans
The interest rate plus the principal amount that must be repaid over time are combined into the monthly instalment amount, or EMI. Recall that the EMI calculation formula is the same for most retail loans, including mortgages and auto loans. Let's use an example to calculate the EMI:
Let's say that X has borrowed INR 10 lakh to construct a home. For ten years, the bank has offered X a home loan with an annual interest rate of 7.2% (floating). The monthly principal and interest (EMI) that he will pay is determined by using the following formula:
P x R x (1+R)^N / [(1+R)^N-1]
P: Principal loan amount = INR 10,000,00
N: Loan tenure in months = 120 months
R: Interest rate per month [7.2/12/100] = 0.006
EMI= INR 10,00,000 * 0.006 * (1 + 0.006)120 / ((1 + 0.006)120 – 1) = INR 11,714.
As a result, for ten years, X would have to pay the EMI of INR 11,714 every month. INR 14,05,702 is the total amount X will pay; INR 4,05,702 will be interest on the principal amount borrowed.
To assist borrowers in reviewing their EMI payments, lending institutions could use a loan amortization schedule to illustrate the breakdown between the interest rates and principal components. The table, based on the previously mentioned scenario, displays the monthly schedule for the first 12 EMI payments and the distribution of principal and interest that X is responsible for paying.
Factors Affecting the EMI Amount
The amount and number of EMIs are subject to change based on various factors such as tenure and current market rates. The following are the main variables that may impact the loan's EMI amount:
Loan amount, interest rate, and repayment tenure
The EMI amount will increase in proportion to the loan amount and the interest rate that lending institutions charge. Depending on how long the loan must be repaid over, this EMI amount may change. A longer repayment period will result in a lower monthly instalment payment, and vice versa.
Fixed or floating rate of interest on loans
The base lending rate, or MCLR, is primarily used by banks to calculate the floating interest rates on loans. Banks independently adjust the MCLR rate, particularly in response to RBI changes to the repo rate.
MCLR is typically used by banks as an "internal benchmark" to fix their lending rates, or floating interest rates on loans. When it comes to the loan's repayment period, the EMI amount fluctuates in tandem with changes in the base rate.
Fixed interest rates are comparatively higher than floating rates. For loans with fixed rates of interest, the amount of the monthly instalment stays the same throughout the repayment period.
Pre-payment or foreclosure of loans
Borrowers can lower the amount of EMIs left by foreclosing on their loans. Before the planned closing date, loans can be closed by paying the remaining balance in full or in instalments. Recall that, depending on the lender's policy, additional rates and GST may be applied to the lending rate.
Down payment on loans
Borrowers can lower their monthly instalment payments (EMIs) by paying for their loans in full upfront or by setting aside money before applying for a loan.
Compound interest on loan EMIs
On loans, banks may impose compound interest. Compound interest is calculated by adding interest to the principal amount of loans, on top of the interest that has already been accrued. Compound interest, to put it simply, is the interest you pay on interest. The amount of your monthly, quarterly, half-yearly, or annual instalment payments can vary depending on the frequency of calculation.
Compound interest rates can be imposed by lenders in the form of annual percentage rates (APRs), which compute the equivalent monthly instalment (EMI) by factoring in the interest rate, any additional fees imposed by the lender, and the length of the loan. Compound interest in savings accounts or investment products, on the other hand, can help people accumulate wealth.
Mis-payment of EMI on loans
Lending institutions will charge extra interest on top of the instalment amount if the borrower is unreliable or misses payments, extending the scheduled due date by a certain number of days.
To avoid defaulting on a loan, which can result in additional fees and damage to one's credit report, borrowers should make sure that there are sufficient funds in their account for banks to deduct the EMI amount on the due date.
Frequently Asked Questions (FAQs)
What is the formula used in calculating EMI on loans?
The formula to calculate EMI is P x R x (1+R)^N / [(1+R)^N-1] – where, “P” is the principal loan amount, “N” in tenure in months, and “R” is the prevailing interest rate.
What is the loan amortization?
Loan amortization facilitates the presentation of the interest rate and principal component breakdown by lending institutions, as shown in the above-mentioned table, for payments to be made throughout the loan.
What are fixed and floating rates of interest?
The base lending rate, or MCLR, is used by banks to compute the floating rate of interest. When a floating rate loan has a repayment tenure linked to changes in the base rate, the amount of the EMI changes accordingly. The EMI amount is fixed or stays the same during the repayment term for fixed rates of interest.
What is the charge for missing EMI payments?
Lending institutions charge extra interest in addition to the EMI amount as a penalty for late payments made by borrowers who are unable to make their instalment payments. The fees differ between banks. By ensuring that there are sufficient funds in the account for the banks to deduct the EMI amount on the due date, borrowers can avoid the penalty for missing their EMI.
What is loan foreclosure?
Repaying the remaining balance in full or in part before the planned EMI period is known as loan foreclosure. Let's take an example where the loan has a ten-year (120-month) repayment period and you decide to foreclose on the remaining amount after three years (36 months). A higher rate than the EMI amount might be charged by the bank to foreclose the loan.
