How to check if your EMI is calculated correctly
Moneylife Digital Team 07 August 2020 Personal Finance
Most people avail loans to buy a car, buy a house, for higher education or for other personal reasons. Loans often help us complete important life goals even with inflation on the rise. Equated Monthly Instalments or EMIs form a part of repayment of the loan that we have availed. It is a fixed amount paid by a borrower to a lender on a specified date every calendar month. EMI is one part of the equally divided monthly payment made to clear off an outstanding loan within a stipulated time frame.

This EMI consists of two components: the principal and the interest. The principal is paid against the loan amount that one has availed while the interest is paid as a cost of providing the loan. This interest is either charged on the full amount for all EMIs or on reduced or outstanding principal amount left to be paid.

Initially, the interest component constitutes the main portion of the EMI payment. As we advance through the loan tenure, the portion of interest repayment reduces and the contribution towards the principal repayment increases.

The EMI for a loan depends on three key factors:
1) Loan amount – This is the total amount that has been borrowed by an individual.
2) Interest rate – This is the rate of interest charged on the amount borrowed.
3) Loan tenure  – This is the agreed upon loan repayment time-frame between the borrower and the lender.

Two methods of calculation:
1. Flat rate method:
Under the flat rate method, interest is always levied on the total loan amount regardless of the principal amount that you have already repaid.

E.g. Shweta avails a loan of Rs 1 lakh at an interest rate of 8% p.a to be paid back in 3 years. As per this flat rate method, Shweta will pay the interest on the total loan amount of Rs 1 lakh.
The formula to calculate EMI using flat rate method would be:
EMI = (Principal + Interest)/Period in Months
So the calculation would be:
Interest for one year=8/100 x 100000= 8000
Interest for three years=8000x3=24000
EMI = (100000 + 24000)/36 = Rs 3444.44

2. Reducing Balance Interest Method:
As per reducing EMI calculator, interest is always levied on the remaining or the outstanding balance of the loan amount after having repaid certain amount of principal every month. The EMIs in this case remain the same, however, the interest component in the EMI keeps reducing every month.  The EMI payment is directly proportional to the loan amount and interest rates, which implies that with increase in amount and interest rate, the EMI on the loan also increases. However, the EMI is inversely proportional to the tenure of loan, which means that though the amount of paid interest increases with longer tenures, but the EMI payments decrease if the loan is repaid over a longer time period.

The formula to calculate EMI using reducing balance method is:
EMI =
P x {[R x (1+R)^N] /[(1+R)^N-1]}
P = Principal Loan Amount = 100000
R = monthly rate of interest [if the interest rate per annum is 8%, then the rate of interest will be  (8/12)/100=  0.0067 per month
N = loan duration in months or number of monthly instalments = 36
So as per this method the calculation would be:
EMI = 100000 x {[ 0.0067 x (1 + 0.0067)^36] / [(1+0.0067)^36-1]}
=  3,135
You can notice that EMIs under reducing balance method are generally lower than that in the flat rate interest method. The interest component in the reducing balance method would keep reducing every month, thereby saving on interest payments. This is the most commonly used method for calculating EMIs (across all products in India)

One can take the easy way out and use good old Excel for calculating the EMI.

In Excel, the function for calculating the EMI is PMT and not EMI. You need only three variables. These are rate of interest (rate), number of periods (nper) and, lastly, the value of the loan or present value (pv).
The formula which one can use in excel is:
=PMT (rate, nper, pv)
Let us check the EMI for Shweta by using the above formula.
It must be noted that the rate used in the formula should be the monthly rate, that is, 8%/12= 0.0066
The number of periods represents the number of EMIs.
=PMT (0.0066, 36, 100000)= 3,129.94

The result is displayed on screen as negative and in red font, which indicates the cash outflow of the borrower. Another easy way to calculate is to use online calculators. You can check this link where we have shared details of how to use online calculator to find the EMI.  