Equated Monthly Installment (EMI): What is it & How Does It Work?

Picture this: you want to buy your dream car or a cosy new home, but paying the full amount upfront feels impossible. That’s where EMI (Equated Monthly Instalments) comes in to make life easier. An EMI allows you to split your big expenses into smaller, manageable monthly payments, making it possible to achieve your goals without straining your budget. This blog explores What is EMI, how it works, the factors that affect it, and the many benefits it offers. With simple examples, you will gain the knowledge you need to make smart financial decisions. Let’s explore the world of EMIs together! 

 Table of Contents 

1) What is an EMI?  

2) How Does an EMI Work?  

3) Formula for Equated Monthly Installment (EMI)  

4) Examples of Equated Monthly Installment (EMI)  

5) Factors Affecting Your EMI Payments 

6) Benefits of EMI 

7) Conclusion 

What is an EMI? 

An EMI is a fixed amount of money you pay each month to repay a loan. When you borrow money from a bank or financial institution, they allow you to return it slowly over time, rather than all at once. The EMI includes two parts:  

a) Principal: The money you borrowed  

b) Interest: The cost of borrowing that money  

It is calculated in a way that makes the payment amount the same each month. This makes it easier for you to plan your budget.  

EMIs are common for loans like home loans, car loans, or personal loans. The amount of your EMI depends on the following:  

a) Amount Borrowed  

b) Interest Rate 

c) Time taken to repay  

A longer repayment period usually means smaller EMIs, but you may end up paying more interest over time. On the other hand, shorter repayment periods have higher EMIs but lower overall interest costs. 

  

 

How Does an EMI Work? 

Here are the ways how an EMI works: 

Fixed Monthly Payment 

a) An EMI is a set amount you pay every month to repay your loan 

b) It helps you plan your expenses because the amount doesn’t change 

Includes Principal and Interest 

a) The EMI has two parts: the money you borrowed (principal) and the lender’s charge (interest) 

b) Both parts are combined into one fixed monthly payment 

EMI Calculation 

a) The EMI is determined by the loan amount, interest rate and repayment time 

b) These factors decide how much you need to pay each month 

Interest Comes First 

a) In the beginning, most of your EMI goes toward paying the interest 

b) Over time, more of it goes to repay the money you borrowed (principal) 

Same Payment Until Loan Ends 

a) You pay the same amount every month until the full loan is repaid 

b) This makes it easier to track and manage your budget 

Formula for Equated Monthly Installment (EMI) 

The formula to calculate is: 

EMI = [P × R × (1 + R)^N] ÷ [(1 + R)^N – 1] 

Here’s what the terms mean: 

a) P is the loan amount (principal) 

b) R represents the monthly interest rate, calculated by dividing the annual interest rate by 12 

c) N is the number of months for repayment 

This formula helps calculate the set amount you need to pay every month to repay your loan, including both the principal and interest. It makes budgeting easier by giving a clear monthly payment amount. 

Examples of Equated Monthly Installment (EMI) 

If you take a loan of £10,000 for 2 years at an interest rate of 10% per year, your monthly EMI can be calculated using the formula: 

EMI = [£10,000 × 0.00833 × (1 + 0.00833)^24] ÷ [(1 + 0.00833)^24 – 1] 

Here: 

a) £10,000 is the loan amount (principal).  

b) 0.00833 is the monthly interest rate (10% annual interest divided by 12).  

c) 24 is the number of months for repayment (2 years).  

After solving, the EMI comes out to be approximately £460.96. This means you’ll pay £460.96 every month for 24 months. Each payment includes part of the principal and part of the interest, and by the end of 2 years, your loan will be fully repaid. 

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Factors Affecting Your EMI Payments  

Here are some of the factors that affect EMI payment: 

1) Loan Amount  

1) The loan amount is the total money you borrow 

2) Bigger loan amounts mean higher EMIs 

3) Smaller loans lead to smaller monthly payments 

4) Always borrow only what you really need 

2) Interest Rate  

1) The interest rate is the extra cost of borrowing money 

2) Higher interest rates increase your EMI 

3) Lower interest rates reduce your monthly payments 

4) Check for loans with better rates to save money 

3) Loan Duration  

1) Loan duration is the time to repay the loan 

2) Longer durations lower your EMI but increase overall costs 

3) Shorter durations mean higher EMIs but save on interest 

4) Choose a duration that suits your budget 

4) Down Payment  

1) Down payment is the amount you pay upfront 

2) Bigger down payments reduce the loan amount and EMI 

3) Smaller down payments increase the amount you borrow 

4) Try to pay a higher down payment if possible. 

5) Compounding Frequency  

1) This means how often interest is added (monthly, quarterly, yearly) 

2) More frequent compounding increases your EMI 

3) Less frequent compounding can make your EMI slightly lower 

4) Ask about compounding terms before taking a loan 

6) Credit Score  

1) A credit score shows how good you are at repaying loans 

2) A good score gets you lower interest rates and smaller EMIs 

3) A favourable score may lead to higher interest rates and EMIs 

4) Pay your bills on time to keep your score high 

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Benefits of EMI 

Here are the advantages of it:
 

1) Affordable Payments 

a) EMIs let you pay for big expenses in smaller amounts over time. 

b) You don’t need to save up a large amount before making a purchase. 

c) It reduces the financial burden of paying all at once. 

2) Easy Budgeting 

a) Fixed monthly payments help you plan your expenses. 

b) You know exactly how much to set aside each month. 

c) It avoids unexpected financial strain during the loan tenure. 

3) Flexibility in Tenure 

a) Choose a short-term loan for faster repayment. 

b) Opt for a long-term loan for smaller monthly payments. 

c) Flexibility allows you to balance EMIs with other expenses. 

4) Access to Big Purchases 

a) Helps you buy homes, cars, or expensive gadgets without waiting. 

b) Makes investments like education or business easier to afford. 

c) Enables you to achieve goals without exhausting your savings. 

5)  Improves Credit Score 

a) Timely EMI payments reflect positively on your credit history. 

b) A good credit score increases your chances of loan approval. 

c) It helps you secure better interest rates for future loans. 

Conclusion 

We hope this blog has explained to you What is EMI and how it operates. EMI helps in dealing with large expenses by stretching it into affordable small amounts of payments. They assist you to better determine your financial trajectory and allow you to repay debts gradually without throwing your budget off balance. Thus, when the loan amount, the rate of interest and the term of repayment are properly selected, EMIs can be quite a comfortable strategy that can be used to meet certain financial needs without strain. 

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