EMI, or Equated Monthly Installment, is a fixed payment amount paid by a borrower to a lender at a specified date each calendar month. Calculating EMI involves a relatively simple formula, yet understanding its components is crucial.
The formula used to calculate EMI is:
EMI=P×r×(1+r)n/((1+r)n−1)
Where:
- P represents the principal loan amount borrowed.
- r is the monthly interest rate. It’s the annual interest rate divided by 12 (the number of months in a year).
- n stands for the number of monthly installments.
Breaking down the formula:
- Principal Loan Amount (P): This is the total amount borrowed from the lender. The EMI calculation starts with this value.
- Monthly Interest Rate (r): Derived from the annual interest rate. If the annual rate is 12%, the monthly rate would be 1212=1%1212=1%. This rate is crucial as it determines the interest payable on the outstanding loan amount each month.
- Number of Monthly Installments (n): The total number of installments over which the loan is to be repaid. The longer the tenure, the lower the EMI, but it results in higher interest payments over time.
The formula involves the use of exponents and the basic mathematical principles of multiplication and division.
Once these values are plugged into the formula, the EMI amount is calculated. This fixed monthly payment remains constant throughout the loan tenure. However, in the initial stages of the loan, a larger portion of the EMI goes towards interest payments, with the remainder contributing to reducing the principal amount. Over time, the interest component decreases, and the principal repayment portion increases.
Factors that affect EMI
When you take out a loan or purchase anything on EMIs, you agree to pay back the money you borrowed with interest over a set period. The EMI comprises two parts: the principle and the interest. The principal is the money you borrowed, and the interest is the amount you pay to the lender for borrowing the money.
- Principal amount: If the cost of the product is high, the loan amount is high as well, which increases the EMI amount.
- Interest rate: This is the cost of borrowing or purchasing a product on EMIs and is determined by the lender. A higher interest rate would increase raise your total EMI amount. Thus, looking for a lender offering a lower interest rate, or no interest rate can help reduce the burden.
- Loan tenure: This refers to the period over which you choose to repay the loan. A longer loan tenure results in lower EMIs, as the total payable amount is spread over more months. But this means you will pay more interest during the loan period.
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Advantages of EMIs
Equated Monthly Installments (EMI) offer numerous advantages, making significant purchases more accessible for individuals. Some of the most prominent advantages of EMI are:
- Spreading costs: EMI allows spreading substantial expenses over time, easing financial burdens and aiding in better budget planning.
- Enhanced affordability: It makes high-value assets like homes, cars, or gadgets more accessible without draining savings, offering a more manageable payment structure.
- Building credit history: Timely EMI payments contribute to a positive credit history, improving credit scores and opening doors to future financial opportunities.
- Access to favourable rates: A good credit score, built through EMI payments, can lead to access to loans and financial products at favourable interest rates.
- Structured approach: EMI offers a structured and predictable payment plan, fostering financial discipline and responsible spending.
- Financial inclusivity: It enables a broader population to afford significant purchases, promoting inclusivity in accessing assets and goods.