What is the full form of EMI

EMI: Equated Monthly Installment

EMI stands for Equated Monthly Installment. It is a fixed payment amount which a borrower pays to a moneylender at a specific date of each month for a specific period of time. Emi consists of a principal component and interest component that a borrower is supposed to pay to lender over a specific number of years to pay off the loan in full. So, it is an unequal combination of principal and interest rate. If you are planning to take loan from a bank, you must understand how banks work out the EMI so that you could evaluate various loan options of different banks and chose one as per your financial constraints.

How to calculate EMI

The calculation of an EMI depends on three factors which are as follows:

• Interest Rate: Rate of interest charged by the moneylender, e.g. Bank.
• Loan Amount (principal loan): The amount borrowed.
• Tenure of the Loan: The time provided by the lender to repay the entire loan including the interest.

Flat interest rate:

The interest is calculated on the whole principal loan without considering the fact that with each EMI the principal amount is getting reduced. For example, a person wants to buy a car and takes a car loan of 3 lakh, at a flat interest rate 12% and has to pay off it in 3 years then the EMI can be calculated as shown below:

• Principal amount: 300,000
• Flat rate of interest: 12%
• Total duration: 3 years

EMI: Principal amount (300,000) is divided by 36 months + 12% of principal amount divided by 12 months = 8333+3000=11.333

Flat rate of interest is usually applied on short term loans such as car loan and two-wheeler loan.

Diminishing balance interest rate:

In case of Diminishing balance Interest rate, the interest amount varies each month as for the first month interest is calculated on the whole principal loan and for the subsequent months interest is calculated on the outstanding loan amount. The formula or method to calculate the reducing interest amount is given below:

• Principal Loan Amount= 300,000
• Diminishing rate of Interest=12%
• Duration: 3 year Interest for first month = loan amount (300, 000)*(1/12*)*(12/100) =3000 Interest for second month= (outstanding loan amount)*(1/12)*(12/100)

Advantages

• Power to Buy: It enables you buy items beyond your monetary reach by allowing you pay in installments.
• Flexibility: You can consider different EMI options offered by different banks and decide the amount that you want to pay as installments and can also choose the tenure of loan as per your financial position.
• No middleman: You directly pay the EMI to the lender without the hassle of contacting a middleman.
• Protects Savings: It does not hurt your savings as you are required to pay minimum regular payments instead of a lump sum amount.