Loans can be extremely helpful to you in fulfilling many of the needs of your life. Be it a medical emergency, building /buying bigger assets like a house or a vehicle, pursuing your dream of higher education or fulfilling day-to-day needs like buying a mobile or a laptop for online classes of your kids, etc.

As varied your needs could be, there are loans to meet those needs.

What is an EMI?

It is common logic that anything that is borrowed must be paid back. An EMI which is also known as Equated Monthly Instalments is the way of repaying the loan amount and the interest equal instalments through the term of the loan.  The EMIs are designed in such a way that, you pay back a certain portion of the borrowed amount and a certain portion of the interest every month. 

But you may ask, how would I know the amount of interest and principal in my EMI? Or how would you know if the interest charged on your EMI is the right amount? Or what if you do not understand the interest calculation?

Many of our loan customers often ask these questions, so we are bringing out this post to help you understand how EMIs are calculated on your loans.

Different methods of EMI calculation

There are 2 different methods of EMI calculations.

Flat Rate Method: Under this method, the interest on the entire loan amount and the loan amount is added and divided by the number of the term of the loan (in months)

Reducing Balance Method: Under the reducing balance method, a specific formula is used to calculate the EMI.  As every EMI pays off the one-part loan amount, and one part of interest, your outstanding loan amount reduces every month. And the interest for the next month is charged on the reduced principal amount.

An actual example may make these concepts clear. Let us assume you avail a loan of Rs 50000 for a period of 6 months at an interest rate of 16%.

Month	EMI Amount	Principal Repaid	Interest Paid	Principal Outstanding
1	8727	8060	667	41940
2	8727	8167	559	33773
3	8727	8276	450	25497
4	8727	8387	340	17110
5	8727	8498	228	8612
6	8727	8612	115	0

 These EMI schedules can be found on the EMI calculators on various financial websites.

As you can see in the last column, the outstanding principal is reducing each month, so the interest payment also becomes lesser. As the reducing balance method of EMI calculation is beneficial to the borrower, this method is used by banks and other financial institutions.

Just for comparison, if we use the flat rate method, the amount of EMI payable each month would be Rs 9667.

The formula used for calculating EMI

There are EMI calculators on many websites, but what if you are looking to calculate the EMI on your loan? How could you do that? There is a formula that is used for calculating EMI. You could either use the mathematical formula or use the function on Excel on your computer to work out the EMI.

Mathematical formula

EMI = [P x R x (1+R)^N] /  [(1+R) ^(N-1)]

Where P = Your loan amount

          R = Rate of interest charged per month (Ex:16%p.a would be 1.33% p.m)

         N = Tenure of the loan in months (2years = 24 months)

Once you get the EMI figure, the interest portion per month is calculated on the outstanding principal amount and the rest of the EMI amount goes towards repayment of your borrowed amount.

Calculating EMI on Excel

You could also use the formula tab in Excel to calculate your EMI. This could be done on your computer or your phone. The formula to be used is

=PMT (rate,nper,PV)

Where rate = Rate of interest charged per month

           Nper = Tenure of the loan in months

          PV = The loan amount

The online EMI calculators do a good job of calculating these figures for you; however, we have included the formulae just for your information.

Factors affecting your EMI

An EMI can have a major impact on your finances. So, you should know about what factors affect your EMIs. The three factors affecting your EMIs are

•       Your Loan Amount
•       Rate of Interest charged on the loan
•       Tenure of the Loan

The most important factor that decides your EMI is your loan amount.  A bigger loan amount will result in a bigger EMI. The relation between the interest rate and your EMIs is also similar; a higher rate of interest rate will make your EMIs bigger.

But the tenure you choose, and the loan amount do not have direct relation. Longer loan tenure can give you relief from bigger EMIs, but you should be aware that you would end up paying a bigger amount in interest over the period of the loan.

So, you should always think through before going in for any loan. It is good to check the EMI amounts for different tenures and rates of interest and before deciding the EMI amount that best suits your finances. Once you avail a loan, make sure you pay back the EMIs on time

After reading this, do you feel more confident about how EMI is calculated on your loan? Don’t forget to let us know in your comments.