You might have heard the term equated monthly installment or EMI when you want to take a loan. The term is familiar because it is one of the most common forms of loan payment calculation methods. In this article, we discuss how it works and what the two main types are, along with some examples that will help you calculate it using an EMI installment calculator.

What is an Equated Monthly Installment?

The term is used when a borrower takes money from a lender. According to the conditions discussed before taking the loan, the borrower returns the money in equal monthly payments. The date each month, the interest rate, and the total duration is fixed. The borrower continues to make periodic payments until they can fulfill the principal amount.

The most common forms of loans that employ this method are car loans, student loans, and mortgages. The primary benefit of this loan return method is that you know exactly how much money you have to pay each month, giving you peace of mind. As the amount doesn’t change, you can easily make a budget around the payments and can ease more by making automated payments each month.

How to Calculate Equated Monthly Installment?

To understand how an EMI installment calculator works, we first have to discuss the two types of equated installments. The first is flat-rate, while the second is reducing balance. Let's first discuss the calculation and then, through examples, see which one is beneficial to you if you can choose.

Flat Rate Calculation Method

In this method, you first have to calculate the total interest amount on the principal amount.

Principal amount x No. of Years x Interest rate

You add it to the principal amount, and this will be the total amount that you need to pay. Now, divide it by the number of months in the total duration, and you get the monthly payment.

So, for example, if you take a loan of $500,000 for ten years, having the interest rate fixed at 3.5%, the interest amount will be $175,000. Your total debt will now be $675,000. Dividing it by 10x12=120 months will give you a monthly payment of $5,625.

So now you have to pay the same amount each month, starting from the first to the last month. The amount remains the same.

Reducing Balance Method

This Equated monthly installment method is a bit different. As you can see from the formula below, the divisor reduces one month each time you make a payment.

$500,000 * [(0.0029 * (1 + 0.0029)^120) / ((1 + 0.0029)^120 - 1)]

Here, you calculate the number 0.0029 by dividing the interest rate 3.5 by 120, the total number of months. Now, after you have made the first payment, which will be $4,944.29. In the next month, the calculation reduces the amount that you pay from the principal amount and then multiplies it by the interest factor. This method makes the interest amount portion lower than the first month.

Each month, the interest amount reduces while the equated amount increases, and in the final months, the interest amount is negligible. With this method, the total interest amount is much lower than the fixed-rate method as it decreases. So, in the reducing balance method, you are paying less overall.

What are Some Factors Affecting the Equated Monthly Installment Amount?

Let's look at some of the significant factors contributing to the variance in equated amounts, which is ultimately based on the lender.

Total Loan, Interest Value, and Total Duration

The higher the amount of loan you take with higher interest rates, the more prominent your Equated monthly installment for each month will be. The duration also matters a lot because it means you have to pay interest for a more extended period. Though the monthly equated amount will be less, let's say in 10 years, than if you choose five years to pay off.

Paying Early or Foreclosure

If you apply for a foreclosure, you can reduce the equated amount by months and can close your loan much earlier than initially intended. It is your choice in the end whether you want to pay more than the amount you chose. Be aware of the additional amount you have to pay for foreclosure, as most banks will charge you based on their policies.

Downpayments

It is always a good idea to save some money before applying for a loan. This way, you can pay a substantial amount as a downpayment. It will help you lower your Equated monthly installment and reduce the overall interest you will be paying.

Equated Monthly Installment FAQs

How is Equated Monthly Amounts Deducted From My Credit Card?

If you use the facility of repaying through this method using your credit card, the first thing is your credit card limit will be reduced according to the loan. Ultimately, it will then function as any other loan or mortgage. Most credit cards will use the reduced balance method to make the payment calculations.

Is the Equated Mthod Good or Bad?

Ultimately, it depends on your philosophy or how you think about taking loans. In its essence, the amount doesn’t change, and you don’t need to worry about how much you have to pay each month. The amount is fixed, and you can manage your budget around the monthly payments.

Final Words

In this article, we discussed the method of paying equal loan payments each month, which you pay on a fixed date. The amount you pay each month includes both your monthly installment of the principal amount and the division of interest amount of the principal amount. You can take a loan either with the flat-rate method or using the reducing balance method.

The fix-rate method is easier to understand as the amount each month doesn’t change. While it may be challenging to understand reducing balance, it is cheaper to use. Finally, it all depends on what you want to pay each month and how streamlined your budget is.