What Is EMI And How Is It Calculated?
You must pay an equivalent monthly installment 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 installment 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, X would have to pay the EMI of INR 11,714 every month for ten years. The total amount X will pay is INR 14,05,702, and 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. Based on the previously mentioned scenario, the table 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 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 will increase proportionately to the loan amount and the lending institution's interest rate. This EMI amount may change depending on how long the loan must be repaid. A more extended repayment period will result in a lower monthly installment 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. Regarding the loan's repayment period, the EMI amount fluctuates with changes in the base rate.
Fixed interest rates are comparatively higher than floating rates. The monthly installment stays the same for loans with fixed interest rates throughout the repayment period.
Pre-payment or foreclosure of loans
Borrowers can lower the amount of EMIs left by foreclosing on their loans. Loans can be closed before the planned closing date by paying the remaining balance in whole or installments. Recall that additional rates and GST may be applied to the lending rate depending on the lender's policy.
Down payment on loans
Borrowers can lower their monthly installment payments (EMIs) by paying for their loans in total upfront or by setting aside money before applying for a loan.
Compound interest on loan EMIs
Banks may impose compound interest on loans. Compound interest is calculated by adding interest to the principal amount of loans on top of the already accrued interest. To put it simply, compound interest is the interest you pay on interest. The amount of your monthly, quarterly, half-yearly, or annual installment payments can vary depending on the calculation frequency.
Lenders can impose compound interest rates in the form of annual percentage rates (APRs), which compute the equivalent monthly installment (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 installment 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 ensure that there are sufficient funds in their accounts for banks to deduct the EMI amount on the due date.
Frequently Asked Questions (FAQs)
What is the formula used to calculate 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 lending institutions' presentation of the interest rate and principal component breakdown, as shown in the table above, for payments to be made throughout the loan.
What are fixed and floating rates of interest?
Banks use the base lending rate, or MCLR, to compute the floating rate of interest. When a floating-rate loan has a repayment tenure linked to changes in the base rate, the EMI amount changes accordingly. For fixed rates of interest, the EMI amount is fixed or stays the same during the repayment term.
What is the charge for missing EMI payments?
Lending institutions charge extra interest and the EMI amount as a penalty for late payments made by borrowers who cannot make their installments. 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 whole or in part before the planned EMI period is known as loan foreclosure. For example, if the loan has a ten-year (120-month) repayment period and you decide to foreclose on the remaining amount after three years (36 months), the bank might charge a higher rate than the EMI amount to foreclose the loan.
