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What is an EMI?
EMI stands for "Equated Monthly Installment" in the context of a loan; it is a fixed amount of money that the borrower must pay to the lender every month for a predetermined number of months, and this fixed monthly sum covers both the original principal amount and the interest generated over the loan's duration.
Generic Formula to Calculate EMI = ((P (1 + r)^n / (1+r)^n) – 1) * r
Where,
P: Principal Amount
r: monthly rate of interest
n: Number of Months
If the rate is given per annum, you have to divide it by 12, and if the loan term is given in a year, you have to convert it into months by multiplying it to 12.
Example: Suppose you buy a Mobile Phone on EMI with the following details:
Price: INR 80,000
Interest rate: 18% p.a. Monthly Rate = 18/12 = 1.5% per month
Number of Months: 12
EMI = ((P * (1+r)^n / (1+r)^n) – 1) * r
EMI = ((80,000 * (1+0.015)^12 / (1+0.015)^12) – 1) * 0.015
Where,
P: Principal Amount
r: monthly rate of interest
n: Number of Months
If the rate is given per annum, you have to divide it by 12, and if the loan term is given in a year, you have to convert it into months by multiplying it to 12.
Example: Suppose you buy a Mobile Phone on EMI with the following details:
Price: INR 80,000
Interest rate: 18% p.a. Monthly Rate = 18/12 = 1.5% per month
Number of Months: 12
EMI = ((P * (1+r)^n / (1+r)^n) – 1) * r
EMI = ((80,000 * (1+0.015)^12 / (1+0.015)^12) – 1) * 0.015
EMI = 7,334.40
This means you have to pay an EMI of INR 7,334.40 per month for the period of 12 months.
You can also use the pmt function in Excel to calculate your EMI's.
=pmt(rate,nper,pv,type)
Where,
Rate: Monthly interest rate
NPER: Number of Periods or Months of Your Loan Term
PV: The loan's present value, which is equal to the loan amount.
Type: The default is 0, which represents the end of the period; you can also choose 1 if you pay your EMIs at the start of the month.
There are two methods, depending on the loan pattern, through which you can calculate your EMI. They are as follows:
The Reduce Balance Method
This reducing balance method calculates the interest on the remaining outstanding principal amount only. It means that you paid a different amount of interest and principal in each EMI. Interest payments, as a percentage of the outstanding loan, should be a larger component of the EMIs at the start of the loan term. The interest proportion will decrease as you pay your EMI’s over time, and a larger portion of the repayments will go towards the principal payments. This method is often applicable to credit cards, overdrafts (OD’s) and mortgages.
The Flat Rate Method
This flat rate method calculates the interest on the initial or original principal amount when the loan amount is progressively repaid. EMI is determined in this method by adding the whole loan principal and the total interest to the principal and then dividing the total number by the EMI in the long term. The borrower benefits less from this method because they must pay more interest, resulting in a higher effective interest rate than the reduced balance method. This method is often applicable to personal loans and auto loans.
Where,
Rate: Monthly interest rate
NPER: Number of Periods or Months of Your Loan Term
PV: The loan's present value, which is equal to the loan amount.
Type: The default is 0, which represents the end of the period; you can also choose 1 if you pay your EMIs at the start of the month.
There are two methods, depending on the loan pattern, through which you can calculate your EMI. They are as follows:
The Reduce Balance Method
This reducing balance method calculates the interest on the remaining outstanding principal amount only. It means that you paid a different amount of interest and principal in each EMI. Interest payments, as a percentage of the outstanding loan, should be a larger component of the EMIs at the start of the loan term. The interest proportion will decrease as you pay your EMI’s over time, and a larger portion of the repayments will go towards the principal payments. This method is often applicable to credit cards, overdrafts (OD’s) and mortgages.
The Flat Rate Method
This flat rate method calculates the interest on the initial or original principal amount when the loan amount is progressively repaid. EMI is determined in this method by adding the whole loan principal and the total interest to the principal and then dividing the total number by the EMI in the long term. The borrower benefits less from this method because they must pay more interest, resulting in a higher effective interest rate than the reduced balance method. This method is often applicable to personal loans and auto loans.
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