If you have taken any kind of loan in the past, be it a personal loan or a traditional one, one thought which must have crossed your mind is, how is the EMI schedule calculated? As amateur borrowers, oftentimes, when lenders share the loan amortization schedule with us, it can become quite confusing to comprehend the true extent of it at first glance. In situations like this, we can’t help ourselves but think, how did this EMI get calculated in the first place, and that is the exact question we will be answering in today’s blog post.
So, without further ado, let’s get started.
What is EMI?
One of the first and most important aspects we need to understand is the meaning of the term EMI. The industry acronym for Equated Monthly Installments, EMI, can be understood as a financial calculation executed by the lender, such that they can arrive at a monthly repayment structure.
Since in most cases, the loans you take are generally high ticket in the range of ₹10,000 to ₹500,000, expecting a repayment for the whole sum along with the interest might be a far sight, and thus to make it easy for the borrower, lenders often offer the borrower an EMI system such that the borrower can not only repay the loan with ease and less financial stress but also the lender has an assurance of fixed repayment every month.
What Is the EMI Amortization Schedule?
Okay, now that you understand the essence of EMI and how it is calculated, the next aspect you need to focus your attention on is the EMI amortization schedule. In simple terms, the EMI amortization schedule can be understood as a glossary of the entire repayment schedule the lender shares with you. Right from the exact amount you are supposed to repay every month along with the dates of the repayment, everything is conveniently shared in the amortization schedule such that both you and the lender are aware of when and how much to repay.
Along with this, the amortization schedule also acts as a reference document for both the stakeholders such that you are always on the same page.
How Is Your EMI Calculated?
EMI calculation across the world, irrespective of the lender you choose, follows a standard set of procedures. The mathematical formula to calculate the EMI of a loan is as shared below, and as you can see, there are several individual factors the formula takes into account to reach the final EMI amount.
EMI = P × r × (1 + r)n/((1 + r)n – 1)
In the above formula,
- P represents the total loan amount, meaning how much money you have borrowed from the lender.
- R represents the rate of interest the lender is charging you.
- N represents the total tenure of the loan.
As the name suggests, EMI is always calculated on a monthly basis and not on a yearly or quarterly basis.
Extending the earlier point, all the 3 variables the EMI formula takes into account, have a significant impact on determining its final value.
Let’s understand each of them in detail.
- Loan Amount
The first and most important factor the EMI formula takes into account is the loan amount, represented by P. Also known as the principal amount, this is essentially the total amount of funds you have actually borrowed from the lender, and thus it goes on to portray that higher the loan amount you borrow, the higher will be your EMIs and vice versa.
- Rate of Interest
Second, to the principal or the loan amount, the rate of interest being charged to you by the lender has a significant impact on your EMI amount. Similar to the principal amount, the higher the rate of interest being charged by the lender, the higher will be your EMI amount. However, in contrast to the other factors, the methodology of charging interest on the loan might vary between lenders.
For example, some lenders might choose to charge you a fixed rate of interest, while on the other hand, the rest might choose to charge you a floating interest rate or a reducing balance interest rate. Thus, it is important that you understand the significance of each of them.
As the name suggests, a fixed rate of interest is a type of interest which remains the same throughout the tenure of the loan and is not changed under any circumstances. Generally, most lenders charge you a fixed interest rate, as it benefits from having consistency on repayments.
On the other hand, a floating interest rate essentially suggests that the rate of interest being charged on your loan might change from time to time depending on the market conditions. While a floating interest rate system is rare among lenders, there have been past instances where lenders have followed this methodology, making it important for you to be aware of it.
Lastly, a reducing balance interest rate system suggests that you will only be charged interest on your outstanding loan amount and not the principal amount as you start repaying the loan. Most commonly offered in vehicle loans, reducing balance interest rates are often beneficial as it means that your EMI amount will get reduced over time.
- Tenure
The last factor considered by the lender is tenure, and as we shared earlier, all loan EMIs are calculated on a monthly basis and not on a yearly or quarterly basis. Similar to the principal amount and interest rate, the longer the tenure of your loan, the higher will be your EMI amount and so on.
In Conclusion:
When you are taking a personal loan or a traditional loan of any kind, it is your responsibility to ensure that you pay back the entire loan amount along with interest on time. While availing the features of a loan, it is easy for us to skip the important bits of repayment, and thus the EMI amortization schedule created by the lender not only allows us to better plan the way ahead but also significantly reduce our financial stress.x
