What is an EMI?
EMI (Equated Monthly Installment) is a fixed payment amount made by a borrower to a lender at a specified date each calendar month. Equated monthly installments are used to pay off both interest and principal each month so that over a specified number of years, the loan is paid off in full.
With most common types of loans—such as real estate mortgages, auto loans, and student loans—the borrower makes fixed periodic payments to the lender over several years with the goal of retiring the loan.
How is EMI Calculated?
The mathematical formula to calculate EMI is: EMI = [P x R x (1+R)^N]/[(1+R)^N-1]
- P stands for the Principal loan amount.
- R stands for the interest rate calculated on a monthly basis. (i.e., if your annual rate is 12%, then R = 12/12/100 = 0.01).
- N is the number of monthly installments. (i.e., for a 10-year loan, N = 120).
Amortization Schedule Explained
An amortization schedule is a complete table of periodic loan payments, showing the amount of principal and the amount of interest that comprise each payment until the loan is paid off at the end of its term.
During the initial years of the loan, a larger portion of the EMI goes towards paying the interest, while a smaller portion pays down the principal. However, as the tenure progresses, the proportion changes: less money pays for interest and more pays off the principal. By the end of the loan term, the entire principal is repaid.
Ways to Reduce Your EMI Burden
1. Opt for a Longer Tenure
While this decreases your monthly outgo, it drastically increases the total interest you will pay over the life of the loan. Use the calculator to find a balance.
2. Negotiate Interest Rates
Even a 0.5% reduction in interest rates can save you lakhs of rupees on a home loan. A strong credit score helps negotiate better rates with banks.
3. Make Prepayments
Whenever you receive a bonus or a lump sum amount, making a prepayment towards the principal reduces the outstanding balance immediately, thereby saving you large amounts of interest in the long run.