How EMI Is Calculated For Your Loan

EMI stands for Equated Monthly Installments. When you take a loan from bank or financial institutions, you are required to pay fixed monthly payments or EMI calculated based on the amount of loan and contracted period.

The best part of fixing Equated Monthly Installments or EMI at the time of taking loan is that the borrower will know precisely how much money they need to pay toward their loan each month. This makes the borrower’s personal budgeting process easier.

Loans like personal, home, car and others are required the How EMI Is Calculated For Your Loanborrower to make a series of monthly payments called EMI for the loan amount over the period.

EMI is directly proportional to the loan amount taken and inversely proportional to time period.

Equated Monthly Installments or EMI has two components – principal and interest amount. The principal portion of the loan is lower in the initial years and slowly increases over the years.

However interest portion of the loan amount is higher in the initial years and slowly decreases over the years as you start paying your EMI.

How to calculate EMI of your loan

To calculated Equated Monthly Installments or EMI, let us consider this example. Mr. X. has taken a home loan of Rs. 10, 00,000 for 5 years at an interest rate of 12%. As discussed, EMI depends on three factors: loan amount, interest rate and tenure of the loan. Let us calculate when interest is charged at a flat rate and also when its on diminishing balance rate.

Interest charged at a Flat rate

Calculation of EMI is also based on the type of interest that is charged. If interest is charged on a flat rate then the calculation will be easy. In flat rate, interest will not be reduced based on the payment of EMI. Based on the loan amount, interest will be calculated at the beginning and both interest and principal amount will be divided by loan tenure to get EMI figure.

Assuming that you are charged with 12% flat rate on your home loan your EMI calculation will be as below;

EMI = {Loan amount + (loam amount* rate of interest* number of years) *} / loan term in months = {10, 00,000 + (10, 00,000*12%*5)} / (5*12) = (10, 00,000 + 6, 00,000)/60 = Rs. 26, 667

Interest calculation based on diminishing balance rate

In this case, with every payment of your EMI, principal portion will get reduced and on the reduced principal amount your interest will be calculated every month. After such calculation, total of interest and principal amount will be added up and divided by the loan period to get EMI.

Formula to calculate EMI = (loan amount*”interest rate per month) * { (1+intrest)^n }/{ (1+interest)^n} -1

Where; n = loan tenure in months = 5*12 = 60

Interest per month = 12% /12 = 0.01

EMI = (10, 00,000 *0.01) * { (1+0.01)^ 60} / {(1+0.01)^60} -1 =  Rs. 22, 244.5

EMI will remain constant over the period of loan. However, if any of these three factors changes then EMI will also change and you need to pay higher or lesser EMI. To pay lesser EMI we suggest you to increase the period of your loan.

Editorial Staff at Yourfinancebook is a team of finance professionals. The team has more than a decade experience in taxation and personal finance.