EMI Explained: How It Is Calculated and How to Lower It

If you have taken a loan in India, Pakistan, the Gulf or many other countries, you have met the EMI: a fixed amount you pay every month until the loan ends. This guide explains what an EMI is made of, how banks calculate it, what changes when the tenure or the interest rate changes, and how to reduce the total interest you pay.

What EMI means

EMI stands for equated monthly instalment. "Equated" means every instalment is the same size. Each one covers the interest on the outstanding balance for the month and repays part of the principal. In the beginning, most of the EMI is interest; towards the end, most of it is principal. The total number of instalments is the tenure.

The formula

EMI = P × r × (1 + r)^n ÷ ((1 + r)^n − 1)

P is the loan amount, r is the monthly interest rate (the yearly rate divided by 12 and by 100) and n is the number of monthly instalments. For a loan of 10,00,000 at 9 percent for five years, r is 0.0075, n is 60 and the EMI is 20,758.36. You pay 12,45,501 in total, so the interest is 2,45,501.

Tenure: the trade-off

Keeping the same loan and rate, changing only the tenure gives:

• 3 years: EMI 31,799.73, interest 1,44,790
• 5 years: EMI 20,758.36, interest 2,45,501
• 7 years: EMI 16,089.08, interest 3,51,483
• 10 years: EMI 12,667.58, interest 5,20,109

Going from three years to ten cuts the EMI by more than half but multiplies the interest by more than three. A long tenure is a useful tool when cash flow is tight, but it is expensive, so choose the shortest tenure that leaves room in your budget.

Interest rate: a small change adds up

On 10,00,000 over five years, an interest rate of 8 percent gives an EMI of 20,276.39, 9 percent gives 20,758.36 and 10 percent gives 21,247.04. One percentage point moves the EMI by roughly 480 and the total cost by about 29,000. On a 20-year home loan the effect is much larger: 25,00,000 at 8.5 percent has an EMI of 21,695.58 and costs 27,06,939 in interest.

Flat rate versus reducing balance

Some dealers and lenders quote a flat rate, which applies the interest to the original amount for the whole tenure. A 9 percent flat rate on 10,00,000 for five years means 4,50,000 in interest and an EMI of about 24,167. The reducing-balance method, used for most bank home and personal loans, charges interest only on what you still owe, so the same 9 percent gives an EMI of 20,758. The effective rate of a flat-rate loan is much higher than its label, often close to double.

Ways to lower the cost

1. Prepay when you can. Lump sums reduce the principal immediately, so less interest accumulates. Check whether your loan has a prepayment charge; floating-rate home loans often do not.
2. Choose to shorten the tenure, not the EMI, when you prepay. Shortening saves more interest.
3. Negotiate the rate. A better credit profile or a competing offer can bring it down by a fraction that is worth thousands.
4. Avoid rolling fees and insurance into the loan. You pay interest on them too.
5. Consider a balance transfer to a cheaper lender if the saving exceeds the fees.
6. Borrow less. A bigger down payment reduces the principal and every number that follows from it.

Watch for these traps

• A low EMI achieved by a very long tenure.
• Processing fees, insurance and other charges added to the loan amount.
• Floating rates that change, altering either the EMI or the tenure.
• Moratorium periods where interest keeps accruing and is added to the balance.

Try it yourself

The EMI Calculator gives your EMI, total interest and total payment for any amount, rate and tenure, with a chart and a yearly or monthly schedule in your choice of currency. The Loan Calculator also compares an extra monthly payment, the Mortgage Calculator suits home loans with taxes and insurance, and the Simple Interest Calculator shows what a flat, non-compounding rate looks like. For a broader look at how loan payments work, read loan payments explained.