Understanding the meaning of EMI is crucial as it is used for various types of credit, such as different types of loans and credit cards. In simple terms, it is a type of repayment plan wherein you repay the lender in monthly instalments. You make these monthly payments for a specified tenure, as decided when availing the credit. Since you are repaying in parts and not in a lump sum, EMIs offer a more convenient way to clear your financial obligations.
Read on to learn what is an EMI, how it works and more.
The full form of EMI is Equated Monthly Instalments. It is a monthly repayment structure associated with several credits. An EMI is a predetermined amount based on your principal amount plus the interest levied by the lender. You pay these instalments for a specified period to clear your debt.
When you get credit, the financial institution computes the interest leviable on the loan amount for the decided tenure. After that, they divide the sum of the borrowed amount and the payable interest into equal instalments spread throughout the repayment period.
You need to pay this EMI on a specific date. The EMI stays the same throughout the tenure of the loan. As you pay an instalment, your total payable amount is reduced by that figure. After the last payment, the credit is closed and you can collect a no objection certificate (NOC) from your lender.
Here are the 2 methods that lenders use to calculate EMIs:
Under the fixed-rate method of EMI calculation, the interest amount is calculated on the principal amount. To calculate the EMI, the total sum of principal and interest is divided into equal instalments. Since the interest rate is fixed, the principal and interest component of the EMI stay the same throughout the tenure.
Here is the formula for the fixed-rate method:
((P x R x N) + P )) / (N x 12)
P is the principal amount
R is the rate of interest
N is the tenure of the loan
Under the reducing-balance method of EMI calculation, the interest amount is calculated on the balance after each EMI payment, i.e., the outstanding amount. Because of this, the interest and principal components vary for every instalment. However, remember that the EMI amount will remain the same throughout your repayment period.
As you pay the instalments, the principal portion increases and the interest portion decreases for every EMI. Here is the formula for this method:
P x R x (1+R)^N/[(1+R) ^ (N-1)]
P is the principal amount
R is the per-month rate of interest
N is the loan tenure in months
Here are the various factors that influence the EMI amount:
The EMI amount contains a portion of the principal amount and therefore, they are directly related. As such, if the credit amount is high, the EMI will be higher and vice-versa.
The interest amount forms a significant part of your EMI amount. Since it depends on the rate, the interest rate directly affects the EMI amount. If the rate is higher, so will be the instalment amount and vice-versa.
The loan tenure is the total period within which you need to repay the loan. Since the repayment period affects how many instalments you will pay, it is inversely related to the EMI amount. A longer tenure will result in lower instalment amounts and vice-versa.
A credit score is a reflection of your creditworthiness. When you have a high credit score, it implies a lower risk of default so you can negotiate the terms to get a lower rate. However, if you have a poor score, the lender will likely levy a higher rate, increasing the EMI amount.
Armed with this information about EMIs, you can better choose a repayment plan. Remember, your interest rates have a significant influence on your EMI amount, so choose a lender that offers pocket-friendly rates, like Fibe. With Fibe, you can get an Personal Loan of up to ₹5 lakhs at rates starting at just 2% per month.
You also have to meet a few basic criteria, submit minimal documentation and apply online to get the funding in just a few minutes. Download the Personal Loan App or log onto our website to apply.
The EMI calculation formula under fixed rate is ((P x R x N) + P)) / (N x 12). Under reducing balance, the formula is P x R x (1+R)^N/[(1+R) ^ (N-1)]. In both cases, P is the principal, R is the interest rate and N is the tenure.
EMI is used to make credit repayment convenient for the borrower. It divides the total payable amount into affordable portions to help the borrower meet the repayment needs and reduce the default risk.
Generally, the financial institution automatically deducts the EMI amount from your bank account on the payment date.
EMI is a good credit repayment option since it allows you to reduce your repayment burden by allowing you to pay in budget-friendly instalments instead of a lump sum amount.