What is EMI? How Are EMIs Calculated?
Learn what EMI means, how banks calculate your monthly installment using reducing balance method, and how to save money on loan interest.
What is EMI?
EMI stands for Equated Monthly Installment. It's the fixed amount you pay to a bank or lender every month until your loan is fully repaid. Each EMI includes both principal repayment and interest.
The EMI Formula
Banks use this formula to calculate your EMI:
EMI = P × r × (1+r)^n / ((1+r)^n - 1)
Where:
- P = Principal loan amount
- r = Monthly interest rate (annual rate ÷ 12 ÷ 100)
- n = Number of monthly installments (loan tenure in months)
Reducing Balance vs Flat Rate
Reducing balance method (used by most banks): Interest is calculated on the outstanding loan amount each month. As you pay EMIs, your outstanding balance reduces, so the interest portion decreases over time.
Flat rate method: Interest is calculated on the original loan amount throughout the tenure. This results in a higher effective interest rate and is less common.
Example Calculation
For a loan of ₹10,00,000 at 8.5% annual interest for 20 years:
- Monthly rate (r) = 8.5 / 12 / 100 = 0.00708
- Months (n) = 20 × 12 = 240
- EMI = ₹8,678 per month
- Total interest paid = ₹10,82,720
Tips to Reduce Your EMI
- Make a larger down payment to reduce principal
- Choose a longer tenure (lower EMI, but more total interest)
- Negotiate a better interest rate
- Make prepayments when you have extra funds