EMI (Equated Monthly Instalment)

What it means

EMI, or Equated Monthly Instalment, is the fixed amount you pay every month to repay a loan. Each EMI has two parts: interest on the amount still outstanding, and a portion of the principal (the original loan). The EMI stays the same each month, but the mix changes. In the early years most of the EMI goes towards interest; towards the end most of it reduces the principal.

How it works

Banks use a standard formula: EMI = P x r x (1 + r)^n / ((1 + r)^n - 1), where P is the loan amount, r is the monthly interest rate (annual rate divided by 12) and n is the number of months.

• Higher rate or longer tenure: a longer tenure lowers the EMI but sharply increases total interest paid.

• Floating rate loans: when the repo-linked rate changes, the bank usually changes the tenure first and keeps the EMI the same, unless you ask for the EMI to change.

• Prepayment: banks cannot charge prepayment penalty on floating rate loans taken by individuals for non-business purposes.

• Tax angle: for a home loan under the old regime, interest is deductible up to ₹2,00,000 a year for a self-occupied house (Section 24(b), old Act section) and principal counts within the ₹1,50,000 limit of Section 80C.

Example

Ramesh takes a business loan of ₹5,00,000 at 10% a year for 5 years.

Monthly rate r = 10% / 12 = 0.8333%

Months n = 60

(1 + r)^60 = about 1.6453

EMI = 5,00,000 x 0.008333 x 1.6453 / 0.6453 = about ₹10,624

First month: interest = ₹5,00,000 x 0.8333% = ₹4,167. Principal repaid = ₹10,624 - ₹4,167 = ₹6,457. Outstanding loan = ₹4,93,543.

Second month: interest = ₹4,93,543 x 0.8333% = ₹4,113, so principal repaid rises to ₹6,511.

Total paid over 5 years = ₹10,624 x 60 = ₹6,37,440, so total interest is about ₹1,37,440.

Key points to remember

• Compare loans on total interest cost, not just on EMI size.

• Prepaying early in the tenure saves the most interest, because that is when interest forms the largest part of the EMI.

• A bounced EMI attracts bank charges and hurts your credit score; keep enough balance before the debit date.

• For business loans, only the interest part of the EMI is an expense in the profit and loss account; the principal reduces the loan liability.