# What is EMI?

Whenever we mention loans, the first question that pops up in our minds is ‘what is EMI?’ Loans have now become an integral part of everyone’s lives. With the wide variety of offers available for educational loans, it has become easier for people to opt for loan options while making big purchases or planning to study abroad in countries like the USA, Canada, UK, Australia, New Zealand, etc. If we try to define EMI in simple terms, it refers to equated monthly instalments that one has to pay for the loan they have opted for. This blog explores what is EMI and its key features.

## What is EMI?

An EMI or equated monthly instalment refers to the payment made by a borrower to a lender during a specified period for each calendar month. Different lenders offer different EMI options to borrowers. The EMI is made up of two components which are:

• the principal amount borrowed and,
• the interest on that borrowed money, which is split across each month of the loan payment period.

Despite the fact that an EMI is a set monthly payment, it is an uneven mix of principle and interest. While for some the interest charges might be high, for some they might be low depending on various factors.

## Factors Affecting EMI

After knowing what is EMI, let’s now try to understand the factors that affect an EMI. The rate of EMI varies depending on various factors specified by banks. Listed below are the factors that affect the same:

• Rate of Interest: It is the interest rate at which the lender gives you the loan. It is critical to conduct preliminary research on market interest rates. Obtaining a competitive rate allows you to calculate the cost of a loan to your advantage.
• Borrowed Principal Amount: It is the amount of money borrowed from the lender. Because interest is determined as a percentage of your principal, the principal is an important consideration when evaluating the cost of your loan.
• Tenure of the Loan: It is the span of time for which you have borrowed. It has a significant influence on the EMI amount. Longer-term loans have lower monthly payments, and vice versa.

## How is EMI Calculated?

Now that we are well versed with what is EMI and the factors that affect EMI in general, let’s now discuss one of the important aspects which students tend to overlook, which is how to calculate an EMI. The mathematical formula that must be followed to calculate EMI is:

EMI = P × r × (1 + r)n / [(1 + r)n – 1]

Where

P = Loan amount

r = interest rate

n =tenure or number of months.

## Different Ways of Calculating EMI

There are essentially two different ways of calculating EMI that has been explained below:

### Flat Rate Method

The principal loan amount and the interest on the principal are added and then the resultant sum is divided by the loan tenure. Eventually, it is multiplied by the number of months in a year. The formula to calculate EMI via the flat rate method is:

EMI = P × r × (1 + r)n / [(1 + r)n – 1]

Where;

• P = Loan amount
• r = interest rate
• n =tenure in number of months.

For example: Assume you have a car loan of ₹10, 00,000. The principal loan amount here is  ₹10, 00,000. The interest rate is 8% for 10 years. Through this method, EMI can be calculated as:

(₹10, 00,000 + (₹10, 00,000 x 10 x 0.08)) / (10 x 12) =  ₹15,000
Thus, the EMI amount is ₹15,000

### Reducing Balance Method

A decreasing balance technique calculates interest on a decreased principal at different periods. The most frequent time intervals in this technique are annual or monthly intervals. An annual decreasing technique calculates interest on the decreased principle at the end of each year.

All loans are repaid in equivalent monthly instalments (EMI), and the principle is decreased every month.

The formula to calculate EMI using the reducing balance method is:

(P x I) x [(1 + r)n] / [t x ((1 + r)n)- 1]

Where,

• P is the principal amount borrowed
• I is the interest rate (annual)
• r is the periodic monthly interest rate
• n is the total number of monthly payments, and
• t is the number of months in a year.

If we use the same principal amount and interest for the above-mentioned example to calculate EMI using this method, then it would be:

((₹10, 00,000 x (0.08)) x (1 + (0.08 / 12)) 120) / (12 x (1 + (0.08/12)) 120 – 1) = ₹12,133.

Hence the EMI amount, in this case, would be = ₹12,133,