EMI

What Is an EMI?

EMI stands for ‘equated monthly instalment’. It is the monthly amount you must pay your lender to repay a loan or debt, such as a home loan, a car loan, a personal loan, etc. EMI is a popular repayment method, as it allows you to purchase expensive things and pay for them in easy instalments. For example, if you want to buy a new car and you do not have sufficient funds, you can take a car loan and pay it back via EMIs. You will just need to make a down payment, which is a lump sum that goes out of your own pocket upfront.
How Do EMIs Work?

When you take a loan, your lender calculates interest for the entire loan period. Then, your loan amount and interest are divided into EMIs, which you must pay on a fixed date. These EMIs include both the interest as well as the principal portions. They remain constant throughout the loan period. An EMI is closed after the payment of the last instalment, and you can collect a NOC (no objection certificate) from the lender.

You also have other options to reduce or close your EMIs. You can prepay your total outstanding loan amount. But remember, your lender may charge pre-closure and other charges for early loan closure. Also, you can reduce your EMI by partially repaying your loan if your lender allows it. Alternatively, you can transfer your loan to other lenders offering lower interest rates. This will help you reduce your EMIs.
EMI Components

Your EMI consists of two components: principal and interest.

Principal component: It is the repayment towards your original loan amount. In every EMI payment, some portion goes to principal repayment, which reduces your outstanding loan amount with subsequent EMIs.

Interest component: It is the repayment of interest in every instalment. Interest is calculated on the outstanding loan amount for each month and included in your EMI.

In the initial period, the maximum portion of an EMI is interest. Later, principal repayment increases and the interest portion decreases correspondingly.
Factors Affecting EMIs

A number of factors affect your EMIs, such as the loan amount, interest rate, loan tenure, credit score, etc. Let’s understand each of these factors.

Principal: It is the amount you have borrowed from the financial institution. Your EMI and the principal amount are directly related to each other. The higher the loan amount, the higher the EMI and vice versa.

Interest: It is the rate at which you have borrowed the money. Interest and EMIs are directly related to each other. If your interest rate is high, the EMI amount will be high as well and vice-versa.

Tenure: It is the period in which you must repay your loan completely. It is inversely related to your EMIs. The higher the loan tenure, the lower your EMI will be and vice-versa.

Credit score: It is a three-digit number that indicates your creditworthiness to the lender. If your credit score is not good, then there are chances that you will be offered a loan at a higher interest rate, which will result in a higher EMI. So, it is advisable to maintain a healthy credit score to get the best loan offer. Generally, a credit score above 750 is considered good.
How Is an EMI Calculated?

You can calculate your EMI in two ways: the fixed-rate method and the reducing-balance method.
Fixed-Rate Method

Under the fixed-rate method, the interest amount remains unchanged over the complete loan duration. It means your monthly repayment towards principal and interest will remain the same throughout the loan tenure, irrespective of the amount repaid in instalments.

In this method, the total interest is computed for the initial borrowed amount. Then, the total interest and principal are paid in equal monthly instalments over the loan period.

You can calculate your EMI by using the following formula: