How EMI Works: A Beginner’s Guide to Managing Loan Repayments

EMI is different from variable payment plans, where a borrower can pay higher amounts. In EMI plans the borrower needs to pay only one fixed payment each month.

In modern financial planning, loans have become an essential part of our lives. Loan helps individuals get over any temporary financial crisis such as purchasing a car, home, or funding education. While loans provide flexibility, understanding Equated Monthly Installments (EMIs) is important for effective financial management. EMIs reduce your financial obligations with periodic payments. In this blog, we will explore EMI, how it works, why it matters, how to calculate it and more.

What is EMI?

An Equated Monthly Installment (EMI) is a fixed amount of capital a borrower pays monthly to the lender until the loan is fully repaid. EMI includes both the principal amount of the loan as well as the interest charged on it.

These days EMI is a preferred way of paying off loans as it saves the borrower from the pressure of paying the entire loan amount in one go. Now that we understand the EMI meaning let us understand how it works.

How Does EMI Work?

EMI is different from variable payment plans, where a borrower can pay higher amounts. In EMI plans the borrower needs to pay only one fixed payment each month. The benefit of EMI is that borrowers will know exactly how much capital they need to pay each month for their loan. This makes personal budgeting easy.

To know how EMI works, you should also understand the loan amortisation method. It is basically a table which highlights the details of each payment you make against the loan payment. It is given to you when you purchase anything on EMI, as it helps borrowers understand the repayment structure.

Suppose you purchased a laptop for 2,00,000 on EMI. The EMI comes to around Rs 34,359  per month (over six months). In the first month, you paid interest of Rs. 2000, and the rest amount of Rs. 32,359 is forwarded to the principal amount. This reduces your outstanding loan balance to Rs. 1,67,641. This process continues for the next six months. Here is a table for your understanding.

How is EMI Calculated?

The formula to calculate EMI is simple and widely used for loans across various sectors. The formula is:

EMI = P × r × (1 + r)n / [(1 + r)n - 1]

Here,

P = Principal loan amount

r = Monthly interest rate (Annual Rate of Interest / 12)

n = Number of monthly instalments (Loan duration  in months)

Factors Affecting EMIs

The following are the factors that affect EMI:

• Principal Amount: EMI and the principal amount are directly related to each other. If the cost of the product you purchased is high then the loan amount will be high as well, which increases the EMI amount.
• Interest Rate: The interest rate is the percentage rate at which you have borrowed the funds. Interest rates and EMIs are directly related to each other. If your interest rate is high, the EMI amount will be high as well and vice-versa.
• Tenure: This refers to the period in which you are required to pay off the loan. It is inversely related to your EMIs, so if the interest rate is high then your total EMI amount will also rise.
• Credit Score: It is an important three-digit number which shows your creditworthiness to the lender. If your credit score is low then you will receive a loan at a higher interest rate, resulting in higher EMIs.

Benefits of EMIs

There are multiple benefits of EMIs:

1. Easy Financial Planning: EMIs help borrowers plan their budgets effectively. As EMI can be a predictable payment, it ensures there are no extra expenses in monthly expenses.

2. Affordability: With EMIs, high-value assets like cars, homes, or gadgets are more accessible. This offers a more manageable payment structure.

3. Flexible Tenures: Borrowers can choose loan tenures that suit their repayment capacity. Shorter tenures reduce the interest burden, while longer tenures lower the monthly EMI amount.

4. Improved Credit Score: Regular and timely EMI payments positively impact your credit score, improving your financial credibility. A good credit score can help in securing future loans on better terms.

Conclusion

EMIs provide an effective way to manage large purchases by spreading the repayment over a set period. By offering fixed monthly payments, EMIs make it easier for borrowers to budget and manage their finances without the burden of large upfront costs. For individuals looking to explore new financial opportunities, it is essential to learn how to create passive income in India and how EMIs can help fulfil their needs. Additionally, maintaining timely EMI payments can improve credit scores and enhance financial credibility.

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