A loan is a financial agreement between the lender and the borrower. The agreement contains the details of the sum dispensed to the borrower and also states the amount of interest alongside the principal sum to be paid within a specified period of time. Generally, loans are reimbursed as monthly instalments with the addition of pre-determined interest. These instalments are known as Equated Monthly Instalments or simply EMI. EMI depends upon the amount of loan vouchsafed, interest rate and the time period under which the loan is to be repaid. 

 

Almost all the banks and financial service providers offer online EMI calculators on their web portals, which are used to get an idea about the amount to be paid as instalments for a particular loan. The method is quite simple and can also be calculated manually without any need of hovering over any website.

 

How to calculate EMI 

Apart from online services for EMI calculation, there are two methods to calculate the EMI using a few variables. One can use the Excel spreadsheet or can do the maths manually without any digital means. In both the cases, loan amount, time period and the rate of interest are compulsory to get the EMI amount. Let us dwell further into the aforementioned methods that can be used for EMI calculation.

 

●      Using Excel

If you don’t have internet connectivity at the moment when you need to calculate the EMI immediately, then don’t worry, as your computer has enough potential to do so. Ensure that Microsoft (MS) Excel has been installed in your computer and also keep with you the variables, which will be needed to calculate the EMI. (Note: In Excel, the function for calculating the EMI is PMT and not EMI itself). Thereafter, go through the following steps:

1. Open MS Excel on your computer (Desktop, Laptop or even mobile)
2. Variables you need: the value of the loan or present value (pv), rate of interest (rate), and lastly the number of periods (nper). 
3. Formula to be used in the Excel spreadsheet: PMT(rate, nper, pv).

The result (EMI amount) will be displayed in negative or red.

For example, assume the loan amount to be Rs 10 lakh and it comes with a 10% interest rate p.a and is to be repaid within 20 years.

Then the EMI will be PMT(10%/12, 20*12, 1000000).

(The rate should be used as monthly interest rate, i.e; divide the yearly rate by 12)

 

●      Using mathematical formula

It is said that ‘maths is magic’ and obviously it is, at least for the one who doesn’t have an internet connection for the time and also don’t know how to use MS Excel. You can use a mathematical formula either on a paper or on a calculator to get the EMI amount. In this case too, you need the same variable, namely the loan amount, time period and the rate of interest. 

The mathematical formula you need to use: EMI = [P x R x (1+R)^N]/[(1+R)^N-1], where P is the principal loan amount, R stands for rate of interest and N denotes the number of monthly instalments.

 

Floating rate EMI 

Loans are financial products and its cost largely depends on the market forces and a number of policies of the central bank of the country. To be more specific, factors like the repo rate, cash reserve ratio (CRR) and several other regulations by the government affects the interest rate. Moreover, after the recent notification by the Government of India, the banks are allowed to choose any of the external market factors to decide the interest rates. A borrower can choose between fixed EMI and floating EMI depending upon his/her preference. 

Floating rate EMI, as the name suggests are variable, i.e; is subjected to change with the market scenario. It has a base rate and a floating element and the latter varies directly if there is a change in the former. This means, that the interest rate may change according to the market forces and will, in turn, change the EMI. Usually, floating interest rates are less than fixed interest rates and that too with a sufficient margin. This ensures that the lender will still pay less (generally) if he/she has opted for floating rate EMI compared to fixed rate EMI.  

For example, if the floating rate is 11% and the fixed rate is 15% then even an increment by 3% will not make the floating rate EMI costlier than the fixed rate EMI. 

However, if you have a predetermined budget, floating rate EMI should be avoided. Also, one needs to have an eye over the interest rates, continuously.

 

Flat rate EMI

Flat rate EMI or to say flat rate interest is a predetermined rate of interest where the interest is calculated on the full principal loan amount for the entire term without taking into consideration that periodic payments reduce the loan amount. 

It is calculated by dividing the total principal loan amount by the number of periods and then adding it to the amount of interest. To be sure, the interest amount itself is calculated on the total loan and is then divided by the number of periods, in which the EMIs are to be paid. 

Take the following example:

A loan amount of 12,000 at an interest rate of 5% per year for one year would amount to (12000/12) + (5% of the loan/12), making the EMI be 1,050, to be paid per month for 12 months.

Flat rate EMI is for those people, who have a rigid budget, which they don’t want to change during the entire loan reimbursement period. This also means that it obliterates the advantages gained by the borrower by paying EMIs faster or repaying the loan before the stipulated time period. No matter how fast the borrower repays the loan, he/she will have to pay the same pre-determined interest amount, as decided in the loan bond. However, the key advantage of Flat rate EMI is its simplicity, with its basic lending and borrowing formalities. The calculations itself are not subjected to any kind of change, which to a great extent simplifies the EMI paying process.

 

EMI reducing balance method

The EMI reducing balance method or simply the Reducing Balance Method is the method wherein the interest to be paid depends on the remaining loan amount and hence changes (diminishes) the interest amount after every paid instalment. This type of interest is generally used in housing or mortgage property loans and is highly preferable over Fixed Interest Rate. The reason behind this nothing but the decreasing EMI amount over consecutive payments. 

Let us understand this in simpler words. At first, the interest is calculated on the entire loan amount, which is to be paid in the first EMI. After paying the first instalment, the remaining loan amount decreases and the next interest to be paid is calculated on the remaining loan amount. This reduces the interest and subsequently the EMI itself since the decrement in the loan amount. The process continues and with every payment of the EMI, the interest continues to decrease further. 

To make this more clear, let us take an example. Suppose a customer takes a housing loan of 20 lakh with a 10% interest rate (per annum). The first EMI to be paid will be 19,301, in which the first month’s component in the monthly instalment is 16,666 and the rest 2,624 as repayment of the principal amount. Hence at the end of the first month, the remaining balance becomes 19,97,366 (20,00,000-2624). In the second month, the interest will be charged on 19,97,366 and not the original sum (20,00,000). In this way, the interest goes on decreasing, resulting in the subsequent decrement of EMIs.

With all this knowledge, it is necessary to choose the best option that maximises your saving while reimbursing the loan. Floating rate EMI serves to the borrowers who expect the market forces to play in their tune, while the Flat rate EMI is for those who have a fixed budget and don’t like dealing with external factors. On the other hand, the reducing balance method for EMI calculation is safe as well as economical. This continues to go on decreasing and can also be calculated prior to the payment of instalments.

However, the interest rates in the last two are not influenced by any external factor or market forces, whereas the Floating interest rate, although being generally less but changes accordingly with other indicators.  

A plethora of websites that offer financial assistance and even banks provide options to calculate EMI online. Nonetheless, we have dealt with all calculations and have gone through the ways to calculate the EMI manually.