An equated monthly installment, referred to as EMI, is an integral part of availing any retail loans offered by lending institutions. However, the calculation process to estimate how much you can actually afford can be difficult.
An EMI calculator can help borrowers estimate their monthly payments of loans based on the principal amount, interest rate, tenure, and other factors.
Formula to Calculate EMI on Loans
EMI is a monthly sum of the principal amount plus the interest rate to repay the loan over a period of time. Remember, the formula to calculate EMI is similar for most retail loans, like home loans and car loans. Let’s calculate the EMI with an example:
Say, X has availed a loan of INR 10 lakh to build a house. The bank has offered X a home loan at an annual interest rate of 7.2% (floating) for a tenure of 10 years, then the EMI he will be paying on a monthly basis is calculated 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.
Therefore, X would be paying the EMI of INR 11,714 every month for 10 years. Overall, the total payment X will pay is INR 14,05,702, of which INR 4,05,702 would be the total interest charged on the principal borrrowed sum.
Lending institutions may as well show the break up between the interest rates and principal components using a loan amortization schedule to help borrowers examine their EMI payments. Given the aforementioned scenario, the tabular shows the monthly schedule of the first 12 EMI payments as well as the break up between interest and principal components to be paid by X.
| Months | Principal (INR | Interest (INR) | Principal + Interest (INR) | Balance to be Paid (INR) |
|---|---|---|---|---|
| 1 | 5,714 | 6,000 | 11,714 | 9,94,286 |
| 2 | 5,748 | 5,966 | 11,714 | 9,88,537 |
| 3 | 5,783 | 5,931 | 11,714 | 9,82,754 |
| 4 | 5,818 | 5,897 | 11,714 | 9,76,937 |
| 5 | 5,853 | 5,862 | 11,714 | 9,71,084 |
| 6 | 5,888 | 5,827 | 11,714 | 9,65,196 |
| 7 | 5,923 | 5,791 | 11,714 | 9,59,273 |
| 8 | 5,959 | 5,756 | 11,714 | 9,53,315 |
| 9 | 5,994 | 5,720 | 11,714 | 9,47,321 |
| 10 | 6,030 | 5,684 | 11,714 | 9,41,290 |
| 11 | 6,066 | 5,648 | 11,714 | 9,35,224 |
| 12 | 6,103 | 5,611 | 11,714 | 9,29,121 |
Factors Affecting the EMI Amount
The number of EMIs as well as the amount can increase or decrease with the prevailing market rates, tenure, and other factors. Here are the major factors that can affect the EMI amount on loans:
Loan amount, interest rate, and repayment tenure
Higher the loan amount and the rate of interest charged by lending institutions, higher will be the EMI amount. This EMI amount can vary depending on the tenure for the repayment of loan. The EMI amount one pays monthly will decrease with the increase in repayment tenure, and vice-versa.
Fixed or floating rate of interest on loans
Banks mostly use MCLR as the base lending rate to determine the floating rates of interest on loans. The revision in MCLR rate is done individually by banks, especially when the RBI revises the repo rate.
Typically, MCLR is an “internal benchmark” for banks to fix their lending rates, or floating rates of interest on loans. The EMI amount varies with the change in base rate linked to the repayment tenure of the loan.
Unlike the floating rate of interest, fixed rates are relatively high. The EMI amount remains fixed or unchanged through the repayment period in loans that offer fixed rates of interest.
Pre-payment or foreclosure of loans
Foreclosure of loans allow borrowers to reduce the remaining number of EMIs. Loans can be closed before the scheduled closing date by paying the remaining balance, either in lump sum or partial payments. Remember, additional rates as well as GST may be levied upon the lending rate as per lender’s policy.
Down payment on loans
Making a down payment, or accumulating a certain fund before applying for a loan and paying it as a lump sum, will help borrowers reduce the EMI amount.
Compound interest on loan EMIs
Banks may charge compound interest on loans. In compound interest, the interest on the principal amount on loans is added up on the previously accrued interest. In simple terms, compound interest is the interest you pay on interest, and your EMI amount can vary as per calculating frequency, either monthly, quarterly, half-yearly or annually.
Lenders may charge compound interest rates in the form of annual percentage rate (APR) that calculates the EMI taking into account the interest rate, any fees charged by the lender, and the tenure of the loan. On the contrary, compound interest on savings or investment instruments can be beneficial to earn wealth.
Related: APR Vs Interest Rate: What’s The Difference?
Mis-payment of EMI on loans
If the borrower is irregular or fails to pay the installment and exceeds the scheduled due date for a certain period of days, lending institutions will levy additional interest over and above the EMI amount.
Borrowers should ensure that enough funds are available on the account for banks to deduct the EMI amount on the due date, and hence avoid default on loans, which will cost you extra as well as hamper your credit score.
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 helps lending institutions to present the EMI break-up between the interest rates and principal components, like in the tabular mentioned above, to be paid over the loan period.
What are fixed and floating rates of interest?
Floating rate of interest is calculated by banks using MCLR as the base lending rate. The EMI amount in a floating rate varies with the change in base rate linked to the repayment tenure of the loan. In fixed rates of interest, the EMI amount remains fixed or unchanged through the repayment period.
What is the charge for missing EMI payments?
If a borrower fails to pay the installment, lending institutions levy additional interest over and above the EMI amount as a penalty for missing EMI payments. The charges vary among banks. Borrowers can avoid the charge for missing their EMI by making sure there is enough funds available on the account for banks to deduct the EMI amount on the due date.
What is loan foreclosure?
Loan foreclosure involves making the full or partial repayment of the remaining balance before the scheduled EMI period. For instance, say the loan repayment tenure is 10 years (120 months), but you choose to foreclose the remaining balance within three years (36 months). Depending on banks, an added rate may be applicable over and above the EMI amount for foreclosing the loan.
