What is the full form of EMI
EMI: Equated Monthly Installment
EMI stands for Equated Monthly Installment. It is a fixed payment amount which a borrower pays to a moneylender at a specific date of each month for a specific period of time. Emi consists of a principal component and interest component that a borrower is supposed to pay to lender over a specific number of years to pay off the loan in full. So, it is an unequal combination of principal and interest rate. If you are planning to take loan from a bank, you must understand how banks work out the EMI so that you could evaluate various loan options of different banks and chose one as per your financial constraints.
How to calculate EMI
The calculation of an EMI depends on three factors which are as follows:
Flat interest rate:
The interest is calculated on the whole principal loan without considering the fact that with each EMI the principal amount is getting reduced. For example, a person wants to buy a car and takes a car loan of 3 lakh, at a flat interest rate 12% and has to pay off it in 3 years then the EMI can be calculated as shown below:
EMI: Principal amount (300,000) is divided by 36 months + 12% of principal amount divided by 12 months = 8333+3000=11.333
Flat rate of interest is usually applied on short term loans such as car loan and two-wheeler loan.
Diminishing balance interest rate:
In case of Diminishing balance Interest rate, the interest amount varies each month as for the first month interest is calculated on the whole principal loan and for the subsequent months interest is calculated on the outstanding loan amount. The formula or method to calculate the reducing interest amount is given below: