Should you pay in EMIs? Learn more about them and also how to calculate them
What is EMI?
EMI stands for Equated Monthly Installment. It is the amount you have to pay to your bank/lender on a fixed date, every month, for the entire tenure of your loan period. The EMI is paid in the form of post-dated cheques for the duration of your loan and is in favour of the lender. The lender could be a bank, NBFC, or credit card company, and the loan could be for any purpose – housing, auto or personal/credit card loan.
What does the EMI amount consist of ?
Each EMI consists of payment towards the principal (actual amount borrowed) and the interest on that amount for the entire loan period. In the early years, a higher proportion of the EMI is formed by the interest payment. As the loan matures, the interest component decreases and the principal amount forms a higher percentage of the monthly payment.
Tip: If you are able to afford the option of prepaying part of your loan, it is better to do it in the early months/years of the tenure so that your principal decreases, thereby saving you interest on later payments.
What are the various types of EMI options and how do I choose the best option?
There are 2 types of EMIs to consider when taking out a loan:
1. Fixed Rate EMI – In this option, the interest rate is fixed for the entire tenure of the loan. It is advisable to choose this option when interest rates are expected to rise in the future. This option helps you lock in a lower interest rate for the entire loan period.
2. Floating Rate EMI – Here the interest rate varies in accordance with prevailing interest rates in the market. This option is better if you expect interest rates to decrease during the tenure of your loan. You can then take advantage of lower rates for future payments.
Will my EMI remain unchanged?
Yes, if you take the fixed rate EMI option.
No, if you
1. - Opt for the floating rate EMI: In this case, the interest component of your monthly EMI will change according to current market rates.
Tip: You can have a fixed EMI even with this option by choosing to increase or decrease the loan period. If interest rates drop, the repayment period will decrease, and if interest rates increase, you can maintain a constant EMI by lengthening the tenure of the loan.
2. - Prepay part of your loan at any time before the tenure is over (for both fixed and floating EMI options): Naturally, repaying part of your loan ahead of time will reduce both the principal amount and the interest payment on your subsequent EMIs.
3. - Choose a staggered EMI payment: Some borrowers (especially young people) choose to pay a constant EMI for the first few years, followed by progressively larger EMIs in later years. Thus, if they have taken out a large loan, they can make relatively smaller fixed EMIs in the earlier years and larger payments in later years as their earnings increase.
How is the EMI calculated?
The monthly EMI payment depends on 3 factors
1. The loan amount ( principal)
2. The interest rate you have borrowed at (this could be fixed or variable)
3. The tenure (length of the loan.)
Lenders use a standard formula for calculating EMI. Credit Mantri can help you evaluate the EMIs for various loan options.
Do I need to know how the EMI is calculated?
It is useful to know how much your EMI will be when comparing the loan options offered by various lenders. It is helpful to have this knowledge when deciding which loan scheme to choose.