Today, it’s impossible to imagine buying anything without a loan. With an increase in day-to-day expenses and a rise in inflation, loans have become an integral part of our lives. However, getting a loan nowadays has now become much easier and is far from the cumbersome process it used to be in days gone by.
In fact, getting a loan could turn out to be useful, given the right circumstances. For instance, when it comes to buying a house, a Home Loan may be the smartest option, especially when you factor in the tax breaks that bring down the cost of your loan. But, before you approach a bank or financial institution for a loan, it’s important to know the basics of borrowing and lending so that you don’t regret any decisions later.
Additional Reading: 5 Hidden Home Loan Tax Incentives
The most important component of a loan is the EMI. We’re going to tell you all you need to know about EMIs and how they are calculated.
What is an EMI?
An EMI or Equated Monthly Instalment is a fixed amount of money that you need to pay to your bank or financial institution every month as repayment towards the loan you have taken until your loan is fully repaid.
In simple terms, an EMI, in this case, is nothing but a loan feature that lets you borrow money for immediate use while allowing you to pay it back in instalments over an extended period of time. The EMI value depends on the loan amount, interest rate charged and the tenure.
The EMI is paid to the bank on a fixed date every month via cheque or by setting up auto debit instructions with your bank.
Additional Reading: Simple Ways to Reduce Your Loan EMI
What are the different components of EMIs?
EMIs mainly consist of two parts, namely the principal amount and the interest component. The interest is charged on the principal amount, which is then spread across each month of the loan tenure.
In the early years of the loan, a huge portion of the EMI consists of the interest amount that is payable by the borrower. As the loan matures and the principal progressively gets paid, the outstanding loan amount reduces simultaneously. The interest part thus becomes lower than the principal amount.
BB Tip: If you are able to afford the option of prepaying part of your loan, it is better to do during the early months/years of the loan tenure so that your principal decreases, thereby saving you interest on later payments.
Additional Reading: EMI in Advance vs EMI in Arrears
Will the EMI change during the loan tenure?
The EMI amount may change in the following cases:
You opt for a floating interest rate – If you opt for a floating interest rate, the interest rate on your loan will change whenever the new floating rate is reset by the lender. This will result in a change in your EMIs.
However, you can instruct your bank or lender to not to change the EMI and instead request for a change in the tenure of the loan.
You prepay the loan amount – If you prepay the loan amount during the tenure of the loan, your EMI will change accordingly. As the principal of the loan goes down, the interest due will change based on this new principal. Even in this case, you can ask the lender to change your tenure instead of the EMI. This will help you repay the loan amount quickly.
You opt for progressive EMIs – A few lenders offer the option of repaying the loan through progressive EMIs. Here, you initially pay a fixed EMI for a specific time and after the completion of that term, you start paying larger EMIs. This is generally preferred by millennials who have just started their career and cannot afford to pay large EMIs initially, but who hope to pay larger EMIs as they grow in their profession.
Additional Reading: EMI Payments Explained
What are the factors affecting EMI?
The EMI of any loan is dependent on three major factors:
Loan amount: It represents the amount you have borrowed from the bank. That’s the primary factor that decides your monthly instalments. With an increase in the loan amount, the EMI to be paid also increases.
Rate of interest: It is the rate of interest charged by the bank on your loan. This is determined by the bank or financial institution after making several calculations like your income, repayment capacity, credit history etc.
Tenure: It is the time taken by you to repay the entire loan amount including the interest rate. This will also have a major impact on your EMIs. One should understand that an increase in tenure means that you will have to pay more interest to the bank.
What is Amortisation Schedule?
A loan amortisation schedule is a tabular representation of your loan with the EMI payment. It shows the breakdown of the interest and principal component of the EMI payment. This schedule helps you examine how your loan will progress over time.
It consists of information like period of scheduled payments, the amount borrowed and amount outstanding. In case you want to foreclose or refinance the loan, this schedule will come in handy in such cases. It also provides details of interest for tax-related benefits.
Amortisation Table Illustration
How to calculate an EMI?
Here’s the mathematical formula to calculate an EMI.
EMI= P x r x (1+r) ^n/ ((1+r) ^n – 1)
‘P’ is the amount that you want to borrow.
‘r’ is the rate of interest that is applicable on your loan. It is calculated on a monthly basis instead of the annual rate of interest.
‘n’ is the duration of the loan in terms of months.
Let’s take an example to calculate EMI using the above formula assuming the loan is Rs. 10, 00,000 at 9% p.a. for 15 years.
Principal amount = Rs. 10, 00,000
Monthly interest = 0.09/12 = 0.0075
N = 15 years, or 180 months
EMI = (10, 00,000 x 0.0075) x (10.0075) to the power of 180/ [(1 0.0075) to the power of 180]-1
Therefore your EMI = Rs. 10,142.67, which is a combination of both the interest and principal portion of the loan, to be paid each month.
But, it’s quite a task to calculate your monthly instalments using that complex mathematical formula. So, to make things easier for you, we have various online EMI calculators to assist you.
- Home Loan EMI Calculator
- Personal Loan EMI Calculator
- Car Loan EMI Calculator
- Education Loan EMI Calculator
- Loan EMI Calculator
Make use of these free online EMI calculators to know how much you need to pay each month so you can plan your finances accordingly. Don’t forget, at the end of the day, loans are liabilities and it is in your best interest to calculate the EMIs beforehand to make informed financial decisions and stay out of debt forever!
Now that you know all about EMIs, go ahead and explore our amazing loan offers and choose one that suits your needs. Happy borrowing!