What is an EMI for loan How is EMI calculated How is EMI linked to a loan tenure
What is an Equated Monthly Instalment (EMI)?
An Equated Monthly Instalment (EMI) is a fixed payment made by the borrower to a lender at a specified date, each calendar month. Equated monthly instalments are allocated towards both the interest and the principal each month, so that over a specified number of years, the loan is paid off in full.
In the most common types of loans, such as Home Loans, Auto Loans and Student Loans—the borrower makes a fixed payment (generally monthly), to the lender over the course of several years, with the goal of completing the loan payment.
How does an Equated Monthly Instalment (EMI) work?
An EMI allows the borrower to pay a fixed amount each month towards the loan.
The benefit of an EMI for the borrowers is that they know precisely how much money they will need to pay towards their loan each month, which can make personal budgeting easier. The benefit to the lenders is that they can count on a steady, predictable income stream from the loan interest.
How is EMI calculated?
An EMI is calculated using the below formula:
P=Loan or Principal amount borrowed
I=Annual interest rate
r=Periodic monthly interest rate
n=Total number of monthly payments
t=Number of months in a year.
Considering the above mentioned three governing factors, the EMI payments are directly proportional to the loan amount and interest rates and are inversely proportional to the tenure of the loan. The higher the loan amount or interest rate, the higher is the EMI payment and vice versa. In case of the tenure of the loan, though the amount of total interest to be paid increases with the increase in the tenure, the EMI payments decrease with the increase in the tenure.
Factors affecting your EMIs:
There are 3 major factors that affect your EMIs:
Loan amount: It is the amount you borrow and is the primary factor that decides your EMI. The higher the loan amount, the bigger is the EMI.
Interest rate: Interest rate on your loan is another critical factor affecting the EMIs. EMIs are directly proportional to the interest rate. Banks/Financial Institutions calculate the interest based on several factors like your income, repayment capacity, credit history, prevailing market situation, etc.
Tenure: This is the third factor that affects your EMI. A longer tenure generally means lower EMIs and vice versa. However, a longer tenure also means an overall higher interest outgo at the end of the loan tenure.
Does the EMI change during the tenure?
Under normal circumstances, the EMI does not change throughout the tenure. However, there are certain situations when the EMI may change, including:
Floating interest rate: If you opt for a floating interest rate, the interest changes as per the market dynamics. When the interest rates fall, so do the EMIs.
Loan prepayment: Your EMI changes if you prepay a certain portion of the loan amount. When you prepay, the principal amount comes down, which subsequently brings down the EMIs if you choose to maintain the original tenure.
There would ordinarily be no change in your EMIs for the entire loan tenure, if you have opted for a fixed rate loan. So, if you are taking a loan, especially where the loan amount tends to be higher, such as a Home Loan or Loan Against Property, do evaluate the EMI vs the total interest outflow over the loan tenure and decide what suits you better –
Higher EMI and shorter tenure - you will save on the interest outflow in the long run
Higher tenure and lower EMI - keeps your cash flow comfortable throughout the loan tenure.
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