How EMI Works
Understand the mechanics of Equated Monthly Installments, amortization schedules, and how interest vs principal changes over time.
What is an EMI?
EMI stands for Equated Monthly Installment. It is a fixed payment amount made by a borrower to a lender at a specified date each calendar month. EMIs are applied to both interest and principal each month so that over a specified number of years, the loan is paid off in full.
When you take out a loan, your monthly payments are initially composed mostly of interest, with only a small portion going toward the principal balance. As time goes on, the interest component decreases and the principal component increases.
The EMI Formula
Lenders calculate EMIs using a standardized mathematical formula that considers the loan amount (Principal), the monthly interest rate, and the total tenure in months.
P = Principal (e.g. ₹5,00,000), R = Monthly interest rate (e.g. 8.5% p.a. / 12 / 100 = 0.007083), N = Tenure in months (e.g. 5 years × 12 = 60 months).
The Reducing Balance Method
Almost all modern EMIs are calculated on a reducing balance basis. This means that interest is charged only on the outstanding principal amount. As you pay off the principal each month, the interest for the subsequent month is calculated on a lower base, making the loan cheaper over time.
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