EMI Full Form – Equated Monthly Installments, Types and Calculation

What is the Full Form of EMI?

The full form of EMI is Equated Monthly Installments. It is a fixed monthly payment made by a borrower to a lender to repay a loan over a specified period. Each EMI includes both the principal amount and the interest on the loan, ensuring that the borrower gradually repays the entire loan over the tenure. It simplifies budgeting by offering predictable monthly payments, making it easier for borrowers to manage their finances while fulfilling their loan obligations. One interesting thing about EMI is that over time, the interest component decreases, and the principal repayment component increases.

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Features and Significance of EMI 

Below are some pointers that highlight the features and significance of EMI:

Features:

• EMI ensures predictable, consistent monthly payments throughout the loan tenure, aiding in financial planning.
• Each EMI comprises both interest and principal repayment, with the interest portion reducing over time.
• Borrowers can choose a repayment period that suits their financial capacity, affecting the EMI amount.
• EMI can be based on fixed or floating interest rates, with reducing balance or flat rate calculation methods.

Significance:

• EMIs allow borrowers to spread out large expenses, making it easier to manage finances without financial strain.
• Timely EMI payments improve credit scores, enhancing future loan eligibility and terms.
• EMI structures make high-value financial liability by breaking down the cost into manageable parts.
• Committing to regular EMI payments instills financial discipline, helping in better money management.
• Tax deduction under section 80E of the Income Tax Act helps borrowers to take tax advantage of the amount of interest paid.

 

How Does Equated Monthly Installment (EMI) Work?

An Equated Monthly Installment (EMI) is a fixed payment amount a borrower makes each month towards repaying a loan. 

Understanding how EMI works involves breaking down its components: principal amount and interest amount, and recognizing how the interest portion decreases over time.

Principal Amount: The principal is the original sum of money borrowed from a lender. When you take out a loan, the principal is the total amount you need to repay, excluding interest. For instance, if you borrow INR 100,000, that INR 100,000 is your principal amount.

Interest Amount: Interest is the cost of borrowing the principal amount. Lenders charge interest based on a percentage of the principal, which compensates them for the risk and opportunity cost of lending. Interest is usually calculated annually and is added to the principal to determine the total repayment amount.

 

How EMI Works?

Each EMI payment includes both principal and interest. Initially, a larger portion of the EMI goes towards paying off the interest, while a smaller portion is applied to the principal. As you continue making payments, the principal reduces, which in turn reduces the interest charged on the outstanding principal. This shifting balance ensures that, while your EMI amount remains constant, the portion dedicated to principal repayment increases as the interest burden lessens

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How are EMIs Calculated?

EMI full form i.e. Equated Monthly Installments suggests that it is an amount that remains ‘equal’ over a certain period of time. Let’s understand how this equated amount is calculated.

EMI calculation is done using this formula:

[P × R × (1+R)^N] / [(1+R)^N-1]

Where:

• P is the principal loan amount
• R is the monthly interest rate (annual rate / 12 / 100)
• N is the loan tenure in months

Let’s understand the calculation through an example:

Suppose you take an education loan of INR 50 Lakhs for a period of 15 years at 9% interest per annum. Now:

P = 50,00,000

R = 9/12/100 = 0.0075

N= 15*12 = 180 months

Putting these values in the formula:

50,00,000 * 0.075 * (1 + 0.0075)180 / ((1 + 0.0075)180 – 1) = INR 55,832

Now, the result of the above EMI calculation, 

Monthly EMI	INR 55,832
Total amount to be paid (Monthly EMI*180)	INR 91,28,340
Principal Amount	INR 50,00,000
Total Interest Paid	INR 41,28,340

Factors Affecting EMI Payments?

EMI payments can significantly impact your financial planning. There are several key factors that influence the amount of EMI on a loan:

• Principal Amount: The principal is the total amount of money borrowed. Higher principal amounts result in higher EMIs, as you’re repaying a larger sum. Conversely, a lower principal will lead to lower EMIs.
• Interest Rate: A higher interest rate increases the EMI amount, as you are paying more for borrowing the same principal. Lower interest rates reduce the EMI, making the loan less costly over time.
• Tenure of the Loan: A longer tenure spreads the repayment over more months, resulting in lower EMIs but increased total interest paid. A shorter tenure increases the EMI but reduces the overall interest expense.
• Down Payment:  A higher down payment reduces the loan principal, resulting in lower EMIs. Conversely, a lower down payment means a higher loan amount and thus higher EMIs.
• Credit Score: A higher credit score can qualify you for lower interest rates, which reduces the EMI amount. A lower credit score might result in higher rates and, consequently, higher EMIs.
• Prepayment and Part Payments: Making prepayments or part payments can reduce the principal amount outstanding, thereby lowering future EMIs or shortening the loan tenure. This can lead to substantial savings in interest payments.

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Conclusion

EMI, or Equated Monthly Installment, is a crucial concept in personal finance, especially when dealing with loans. Understanding how EMI works, the types available, and how it is calculated can help you make informed decisions when borrowing money. While EMIs offer the convenience of breaking down large expenses into smaller, manageable payments, they also require careful planning and management to avoid financial strain.

FAQs of EMI Full Form