Equated Monthly Installment

Updated on April 12, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Equated Monthly Installment (EMI)?

An Equated Monthly Installment or EMI is a fixed amount a borrower pays a lender every month. Banks and other financial institutions offer this facility to their customers to take a loan to cover the immediate cash requirement and repay the amount over a stipulated period.

Equated Monthly Installment

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The EMI amount consists of both the principal and interest amounts. The borrower must pay a part of the total loan and interest amount every month on a fixed calendar date. The loan will be written off over time and repaid entirely towards the end of the loan tenure.

Key Takeaways

  • An equated monthly installment or EMI is a facility that banks and other financial institutions offer to customers where they can repay the loan amount in fixed monthly installments over a stipulated period.
  • The customers must pay the loan installment on a specified calendar date every month. The loan amount will be written off over time.
  • An EMI comprises two components which are the principal and interest amounts. In the initial years, the interest amount is higher. It gradually declines over time and reduces towards the loan tenure’s end.

Equated Monthly Installment Explained

An equated monthly installment (EMI) is a facility that banks and other financial institutions offer to their customers where they provide loans for immediate cash requirements. The borrower must pay a fixed amount on a specific calendar date every month to the lender, which is the total loan and interest amount part. The loan gets written off over time and is fully repaid towards the end of the tenure.

The EMI amount comprises two components which are the principal and interest amounts. In the initial years of the loan’s tenure, the EMI amount’s major part consists of the interest amount. However, during the later years, the principal amount constitutes a significant portion while the interest amount part becomes significantly lower.

EMI is one of the most preferred loan payment methods as it benefits both the borrower and the lender. The borrower can choose the payment plan, the monthly installment amount, and the loan tenure based on his financial capabilities. The borrower gets the payment schedule planned out in advance, giving them enough time to be financially prepared. The lender receives a steady flow of income every month until the entire loan amount is repaid. EMI is familiar with various types of loans, including home mortgages, auto loans, and student loans.

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Types

The different equated monthly installment types are as follows:

#1 – Fixed Interest Rate

In this EMI type, the interest rate remains unchanged throughout the loan tenure. As a result, the EMI amount remains the same. Since the monthly installment remains the same, it gives the borrower a clear image of the payment schedule to plan it. Generally, the fixed interest rates are higher by 1% to 2% than the variable interest rates.

#2 – Variable or Floating Interest Rate

In this EMI type, the interest rates vary according to market trends. The lending institutions decide the interest rates. Since the interest keeps changing occasionally, the loan and EMI amount also keep varying along with the fluctuating base amount.

How To Calculate EMI?

The EMI can be calculated in the following ways:

#1 – EMI Calculation

The equated monthly installment formula is as follows:

EMI = P * r * (1 + r) ^n / {(1 + r) ^ n – 1}

where,

  • P = Loan amount
  • r = Monthly rate of Interest
  • n = Loan tenure

#2 – Reducing Balance Method

In this method, the equated monthly installment formula is as follows:

EMI = (P * I) * [(1 + r) n) / t * {(1+r) n}]

where,

  • P = Principal amount
  • I = Annual interest rate on the principal amount
  • r = Monthly interest rate 
  • t = Number of months in that year
  • n = Total monthly payments

Examples

Let us understand this concept with the following examples:

Example #1

John borrowed an auto loan of $2,00,000 at an interest rate of 3.5%, to be paid over ten years. According to the flat rate method, the EMI calculation will be as follows:

EMI = {2,00,000 + (2,00,000 x 10 x 0.035)} / 10 x 12 

        = 2,70,000 / 120 

        = 2,250

Thus, John must pay the monthly EMI, which is $2,250. This is an equated monthly installment example.

Example #2

No-cost EMI has become a popular scheme in recent years as it helps people buy expensive items and repay the amount over a certain period. In addition, a no-cost or zero-cost EMI does not charge any interest to the borrower. It means that the borrower needs to pay only the principal amount. The monthly installment amount includes the loan processing fee and the interest component. This is an equated monthly installment example.

Advantages And Disadvantages

The advantages of EMI are as follows:

  • This facility allows people to buy expensive items without paying the entire amount in one go. It benefits people with fixed incomes who can easily repay the loan over a specified period.
  • It is easier to plan out the entire payment schedule well in advance. Thus, the borrower will always be financially prepared to pay the monthly installment.
  • There is a mediator involved in the entire lending and repayment process. Banks and other financial institutions lend the loan amount directly to the customers. This ensures that no other parties are handling the payment process.
  • Since the repayment is distributed over a certain period, it does not burn a hole in the borrower’s pocket.
  • Financial institutions offer several schemes and monetary benefits to attract more customers. This helps the customers get loans at low-interest rates.

The disadvantages of equated monthly installment are as follows:

  • The customers may fall prey to more extended debt periods as the EMI schemes are designed in a way where the loan repayment tenures are extended for a long time.
  • The interest amount is the extra cost a customer has to pay for availing of this facility.
  • If the customer defaults on an EMI installment, they will be charged an extra fine or late fee.
  • Defaulting on an EMI will also lead to a negative impact on the customer’s credit score.
  • The financial institution may charge extra money as a processing fee.

Frequently Asked Questions (FAQs)

Which is better, EMI or cash?

EMI is a better payment method for purchases that require a lump sum payment. Purchasing expensive things in cash would result in unnecessary locking in of funds. In addition, the locked-in fund would make the customer strapped for money during emergencies. Thus, EMI is a better alternative for significant investments where the customer has a fixed income to pay the monthly installment amounts and can repay the loan within the stipulated time. In recent years, many institutions have offered no-cost or zero-cost EMIs where the customer needs to pay only the principal amount. These schemes will significantly benefit customers over cash payment.

Is EMI split between principal and Interest?

Yes, an EMI comprises two variable components: the principal and Interest. The interest amount is usually higher during the initial years of the loan’s tenure. After that, it decreases over time and reduces significantly towards the tenure’s end.

Can I pay more than EMI every month?

Yes, paying more than the fixed EMI amount every month is possible. It will reduce the outstanding principal amount and decrease the loan burden on the borrower. The borrower can pay one extra monthly EMI installment every year. This will lead to a shorter loan tenure and reduced interest amount.

This article has been a guide to what is Equated Monthly Installment. Here, we explain EMI formula, how to calculate it, examples, advantages, disadvantages & types. You may also find some useful articles here –

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