What Is Emi And How Is It Calculated On Your Loan?

In the past, borrowing by individuals was nearly non-existent. To borrow was considered to be a bad habit; it was socially taboo in the conservative Indian social system. Besides, money was scarce in those days and banks usually preferred to lend to productive businesses.

Well, not anymore. The Indian mindset has changed and we are embracing loans with much enthusiasm. You can now get a loan  for almost anything, not necessarily a productive endeavour. Be it buying a house . a pair of designer jeans, a mobile, a car, household appliances, holidays and what not? You can count on a loan!

The acronym “EMI” has entered an average Indian’s vocabulary in pretty good measure. And most media advertisements now quote the monthly EMI of a product rather than its price thus tempting the reader to buy it.

What is Equated Monthly Installment(EMI)?

‘Equated Monthly Installment’ – EMI’ A settled installment sum made by a borrower to a moneylender at a predefined date every schedule month. Equated Monthly Instalments are utilized to pay off both interest and principal each month, so that over a specified number of years, the loan is paid off in full. When you take a loan, this is the amount that you are expected to pay every month for the contracted period.

How to calculate the EMI on your loan?

Before we delve into how it is calculated, we need to understand what an EMI actually constitutes. It needs no mention that when you take a loan, you need to pay back that amount along with the interest.

An EMI is therefore nothing but a combination of the principal amount and interest. That is, with every EMI you pay back a portion of the loan principal and a portion of the total interest that you are

liable for the whole term. So what is the proportion of principal and interest that an EMI comprises?

To understand this, you need to know the two types of interest rates that you may be charged. They are:

1. Flat rate. Here, the interest is calculated on the whole of the principal amount without considering that the principal is gradually paid over the term period. This type of loan is common with short term loans like automobiles.

The EMI here is nothing but: (Principal + Total interest) / term. For example, if the principal is Rs 3 lakh and the term and rate are 3 years and 12% respectively, then the EMI is:

                             (300000+108000)/36=11,333

Here, every installment consists of a constant proportion of principal and interest.

2. Diminishing balance rate. This type of loan gives due consideration to the fact that the principal reduces with every EMI payment. So, the first installment will pay interest on the whole capital and the subsequent EMIs, on the loan balance as reduced by the principal repaid by the previous EMIs. Long term loans like home loans typically follow this system.

So, for a 20-year loan of Rs 30 lakh @ 8.5% p.a. the EMI in this case would be: Rs 26,034.

As illustrated in the above graph, initially, the EMI will consist more of interest than principal. Over time, this proportion would get reversed. This type of EMI can be calculated easily in a spreadsheet but manual calculations could be laborious.

End note:  In reality, EMI has become a standard expense column in our financial budget . It would pay to understand well how your EMI is calculated.

Source: www.itsallaboutmoney.com

Category: Credit

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