We hear the term EMI very often in our day-to-day life. Whether it is a student loan, home loan, car loan, or any similar type of loan, the monthly installments you have to pay to the lender are EMI or Equated Monthly Installment. You can now also buy many products like a mobile phone or a laptop on the EMI plan by paying the minimum required amount on purchase and then paying the remaining amount in the form of an EMI. But what does the EMI actually mean, and how does it benefit you as a borrower? To understand this, let’s go through the Equated Monthly Installment or EMI basics and see how it works.
What is an Equated Monthly Installment or EMI?
As it is popularly known, equated Monthly Installment or EMI is a fixed amount of payment made by a borrower to the lender each month at a specific date which is pre-determined at the time of lending the loan, product or service. These installments are applied to the principal and interest amounts so that the borrowed loan is easily paid off in steps over a specified number of years. The concept of Equated Monthly Installments or EMI works really well with certain types of loans, including auto loans, real estate mortgages, student loans, and many more where the borrower of the loan makes fixed monthly payments over several years to the lender to get the complete loan amount paid off.
The Equated Monthly Installments or EMI is often the preferred way of paying off the loans as this method tells the borrowers a fixed amount to be paid every month on a pre-determined date. Knowing the amount to be paid every month gives the borrowers peace of mind as they are not pressured to pay the entire amount in one go, and they can manage their finances every month keeping in mind the set amount to be paid.
How does an Equated Monthly Installment or EMI work?
Equated Monthly Installment or EMI is not similar to the variable payment plans where the borrowers can pay a varied amount of money according to their convenience. In EMI plans, a fixed amount is decided, which is to be paid periodically that is on a fixed date of every month. This Equated Monthly Installment or EMI plan aims to provide better financial management to both the borrower and the lender and to pressure the borrower.
In a way, the Equated Monthly Installment or EMI plan benefits both the borrower and the lender, and that is why it is also the most preferred plan of loan payment as compared to any other payment plan. By choosing to pay through EMI, the borrower is benefited as they will know the fixed amount of payment to be made every month and will be able to manage their savings and spendings accordingly. The lenders on the other hand benefit from EMI because they get a fixed source of income from the monthly EMI payments that are made to them by the borrowers.
As the Equated Monthly Installment or EMI has gained more and more popularity, it is also available for various other products and services and online shopping. You can easily buy your dream phone, laptop, or other expensive product by opting for an EMI plan and paying the complete amount in monthly installments.
How is the Equated Monthly Installment or EMI calculated?
Equated Monthly Installment or EMI can be calculated using the Flat rate method and the reducing balance method. To know how each of these methods works and how you can use them to calculate the EMI amount, let’s go through these calculation methods one by one.
1. Flat rate method
Equated Monthly installment or EMI using the Flat rate method is calculated by adding the principal loan amount and the interest on the principal sum and then dividing the total outcome by the number of periods multiplied by the number of months. Let’s understand this calculation with a relevant example.
For example: You borrow a student loan of 2,00,000 rupees at an interest rate of 3.5%, which is to be paid over a period of 10 years. According to the flat rate method, the calculation of EMI will be as follows:
EMI = (2,00,000 + (2,00,000 x 10 x 0.035) ) / 10 x 12 = 2,70,000 / 120 = 2,250
Hence, according to the above calculations made using the flat rate method, the amount to be paid every month as the Equated Monthly Installment or EMI is 2,250 rupees.
2. Reducing balance method
The formula for calculating the Equated Monthly Installment or EMI using the reducing balance method is as follows: (P x I) x ( (1 + r)n ) / (t x ( (1+r)n )
Here,
P stands for the principal amount which is borrowed.
I stand for the annual rate of interest on the amount.
r stands for the monthly rate of interest to be paid
t stands for the number of months in the year
n stands for the total monthly payments
You simply have to put the values in the above formula to get the value of EMI, which is to be paid every month.
You can use one or both of these formulas to calculate your loan amount's Equated Monthly Installments or EMI.
What are the factors that affect the Equated Monthly Installments or EMI?
The three major factors that affect the EMI are Principal loan amount, rate of interest and loan tenure. Let’s go through them one by one to see how they affect the EMI.
1. Principal loan amount
The principal loan amount is the original loan amount that the borrower borrows from the lender. This is the main factor that decides the EMI amount. The higher the principal loan amount higher will be the EMI.
2. Rate of Interest
This is the interest rate that is charged on your loan and is also an important factor in deciding the EMI amount.
3. Loan tenure
It is the period given to the borrower within which the entire loan has to be paid off by the borrower. Longer tenure implies that the borrower needs to pay interest for a longer period to the lender.
