To make large expenses and commodities affordable and within reach to the masses, financial institutions often offer the customers the luxury of splitting those expenses into smaller repayments amounts, or as they are commonly called EMIs. Let’s take a closer look at what is an EMI and how it is calculated.
What is EMI?
The full form of EMI is Equated Monthly Instalment, and it refers to the fixed monthly payment made to a lender to repay a loan or debt, such as a home loan, car loan, or personal loan. It is a widely preferred repayment method as it enables individuals to afford costly purchases by breaking the payment into manageable instalments. For instance, if you wish to buy a new car but lack sufficient funds, you can opt for a car loan and repay it through EMIs. To initiate this, you will need to make a down payment, which is an upfront lump sum paid from your own funds.
Now that you know what an EMI is, let’s deep dive into the subject.
How does an EMI work?
Equated Monthly Instalments (EMIs) are a common method of repaying loans. The borrower pays a fixed amount each month, consisting of both principal and interest components. Initially, a larger portion goes towards interest, with the principal repayment increasing gradually. The EMI remains constant throughout the loan tenure, simplifying budgeting for borrowers. Lenders use the reducing balance method, recalculating interest on the outstanding principal. Early EMIs contribute more towards interest, while later ones focus on principal repayment. Understanding EMI helps borrowers plan repayments effectively and manage their finances, making significant purchases like homes or vehicles more accessible over time.
How is EMI calculated?
EMIs are calculated using two primary methods—the Fixed-Rate Method and the Reducing-Balance Method. The choice of method impacts the overall interest paid and the EMI amount.
Fixed rate method
In the fixed-rate method, the interest is calculated on the entire loan amount for the loan tenure, and the EMI remains constant throughout the repayment period. The formula used is:
EMI = [P x R x (1+R)^N] / [(1+R)^N-1]
Where P is the principal amount, R is the monthly interest rate, and N is the loan tenure in months. This method offers predictability, as you pay the same amount every month, regardless of the loan progress.
Reducing balance method
In the reducing-balance method, the interest is calculated only on the outstanding principal amount. As you pay each EMI, the principal reduces, resulting in a gradual decrease in the interest portion. The EMI still remains constant, but the interest paid decreases over time, while the principal repayment increases. This method is more cost-effective for borrowers, as the total interest payable is lower compared to the fixed-rate method.
To ease the tedious task of manual calculation, you can use our personal loan EMI Calculator. With this online tool, you only need to enter the loan amount you need, the prevailing interest rate and the tenure for which you need the loan. The tool automatically does the calculations and shows the possible EMI for the details entered.
Factors that affect EMIs
EMIs are influenced by various factors that determine the loan repayment structure. Understanding these elements helps you plan your finances better:
- Loan amount: The principal amount borrowed directly impacts the EMI. Higher loan amounts lead to higher EMIs.
- Interest rate: The rate of interest charged by the lender plays a key role. A higher interest rate increases the EMI amount.
- Loan tenure: The loan duration affects the EMI. A longer tenure reduces the monthly payment but increases the total interest payable.
- Repayment method: Whether the interest is charged on a fixed-rate or reducing-balance method influences EMI calculations.
- Prepayment: If you make partial payments towards the principal, it can reduce the EMI or loan tenure.
By analysing these factors, you can choose the best loan repayment plan that suits your financial situation.
Advantages of EMIs
EMIs provide several benefits, making them a convenient repayment method:
- Financial flexibility: EMIs allow you to afford big purchases without draining your savings at once.
- Fixed payment schedule: The structured monthly instalments make it easy to plan and manage finances.
- Affordable repayment: By dividing the loan into smaller monthly payments, EMIs reduce financial strain.
- Improves credit score: Timely EMI payments build a good credit history and improve your creditworthiness.
- Wide applicability: EMIs are available for various loans, including home loans, car loans, and personal loans.
With EMIs, you can achieve your financial goals without compromising your budget.
Tips to lower your personal loan EMIs
Now that you know how personal loan EMI is calculated. Here are some tips that can help you in lowering your personal loan EMIs:
- Select the appropriate tenure of the loan
Choosing the right loan tenure plays a vital role in effectively handling your EMI payments. Opting for a longer duration reduces your monthly EMI but increases the overall interest expenses. Striking a balance between these two factors is crucial. People who want to prioritise lower monthly payments might opt for a longer repayment plan, while those aiming to minimise interest expenses might prefer a shorter tenure. - Calculate EMIs before taking out a loan
It is recommended to perform thorough calculations and carefully plan your finances, EMIs, and loan duration before proceeding with the loan application. We provide a personal loan EMI calculator that helps you to conveniently estimate your monthly payments and interest rates. This user-friendly tool is readily available on our website and comes at no cost to you. - Negotiate the interest rate
Engaging in negotiations to lower the interest rate can be a highly effective strategy for decreasing the monthly EMI repayments of a personal loan. The interest rate directly impacts the borrowing cost, and securing a lower rate can significantly reduce the total repayment amount throughout the loan tenure. Moreover, a reduced EMI can help you effectively manage your monthly finances and reduce the overall financial strain associated with the loan. It is important to research interest rates and find the best offer and negotiate with the selected lender to secure a favourable interest rate. - Make prepayment
Prepayment refers to the act of repaying a portion or the entire loan amount before the end of the chosen loan tenure. This action significantly reduces the outstanding principal balance and later lowers the monthly EMIs, making the loan more manageable. Furthermore, making a larger down payment enhances your creditworthiness and increases the chances of loan approval at a reduced interest rate. It is crucial to thoroughly evaluate your financial situation and repayment ability before deciding on the prepayment amount.
Conclusion
EMIs are a practical solution for managing large expenses, enabling borrowers to repay loans through structured monthly payments. Understanding the factors that influence EMIs and choosing the right repayment method can help you save on interest and manage your finances effectively. Whether for a home, car, or personal loan, EMIs ensure affordability and financial discipline, making them an integral part of modern borrowing.
Bajaj Finance Limited offers a high value personal loan with flexible repayment tenure and quick disbursal.
To help you make informed decisions, we provide a personal loan EMI calculator that enables you to estimate your monthly EMIs in advance, allowing you to plan your loan repayment journey with foresight.
