How EMI is calculated!!

I decided to purchase a house in Banaglore (an extremely tough task) and the first thing that struck me is equated monthly installment or EMI. This is the single most important parameter while taking any kind of loan. This is the amount outgo every month from your personal finances which will cover both the principle as well as interest.

I talked to few people and everyone is bit confused on how EMI is calculated. It is really simple and just few steps would enable you to calculate EMI at your end.

So here is a rather simply formula for calculating EMI.

You would wonder why EMI is called "equated", the reason is that EMI is nothing but loan amount plus total interest divided by loan tenure. If that is the case then why this complicated formula. The reason is because as you keep paying EMI, some portion of EMI goes as interest but some portion goes as principal repayment. So if you pay an EMI of Rs10,000 for a house loan, not the entire Rs 10,000 would go as interest payment, but some portion goes as principal repayment, which essentially reduces the principal on which further interest is calculated. It is extremely important to understand what goes for interest and what goes for principal repayment.

It is very clear (for mathematically inclined) that when Loan Amount goes up, so does the EMI. Similarly if the interest goes up again so does the EMI, but if 'n' (loan tenure) goes up, EMI reduces. A note of caution, a low EMI for longer period does not necessary means a good bargain. A good bargain depends on your requirements as well as the total interest you pay over the entire loan tenure.

Another thing to keep in mind is whether the reduction in loan amount happens on monthly basis or yearly basis. Any loan which reduces the principal on monthly basis should be given preference. A monthly reduction implies less interest payment from next month onwards, definitely a huge savings.

Also usually interest rates comes in flavors of fixed and floating rates. A floating rate changes based on market's prime lending rate (PLR). A fixed rate stays fixed for the tenure of the loan. For a longer period of loan, my personal preference is always fixed interest rate, even if it is 1-2% higher, at least the monthly outgo is fixed, so planning of your outflows can be planned pretty well. I personally think that similar to rupee averaging for mutual funds, the floating rate almost remains same as fixed rate over a long tenure of loan. [The floating rate will go up and down and hence your monthly outgo]. And for short tenure loan, in a high interest regime, go for floating rate, but in a low interest regime choose fixed rate.

12 comments:

  1. Rodrigo11:40 AM

    Oi, achei teu blog pelo google tá bem interessante gostei desse post. Quando der dá uma passada pelo meu blog, é sobre camisetas personalizadas, mostra passo a passo como criar uma camiseta personalizada bem maneira. Até mais.

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  2. Sagar5:38 PM

    Thank you very much for the EMI Formula:

    It really helped me a lot...
    Thanks again

    ReplyDelete
  3. Hi,
    The informations here are useful.
    I'm on the look out for a home loan.
    As people on this post may be aware, the banks have almost stopped giving down-payment for under-construction property. So, customers like me are forced to go for construction-linked plans where some x% of sanctioned loan amount is disbursed every 2-3 months. The EMIs in this case start with small amount and go up in step with the disbursal.

    Can someone share how to calculate the EMI, Interest and Principal outgo in such a situation ?
    It will be really helpful.

    Thanks,
    AG

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  4. Rathan2:12 AM

    That is some very helpful information you have posted my friend. Thanks for sharing !
    Happy New Year.

    ReplyDelete
  5. Anonymous12:30 PM

    it's really very helpful but i want more in depth with full practical calculation.

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  6. Anonymous5:27 PM

    Thank you for visiting the website.

    KM

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  7. Anonymous4:29 PM

    hi this is vijay emi formula was very helpful but it would have been better if it was with an calculation example thank you

    ReplyDelete
  8. Hi Vijay, thanks for visiting the blog. I will write another post on this definitely giving an example.

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  9. Anonymous7:02 PM

    How is the total interest amount to be paid calculated? Does it depend on what percentage of EMI goes towards principal repayment?

    ReplyDelete
  10. Hi Anonymous,

    Check out this post to calculate the interest component

    http://greenbuck.blogspot.com/2007/07/emi-calculation-using-excel.html

    Thanks for visiting the blog.

    ReplyDelete
  11. Anonymous5:23 PM

    thanks for this tips 2218153698

    ReplyDelete
  12. Anonymous7:55 PM

    thank you for the easy explanation

    ReplyDelete