When you apply for a loan irrespective of whether it is a personal loan, home loan or car loan, the second most important (the first being the interest rate) aspect you should consider is your monthly installment.
It is called equated monthly installment since it is the same amount you will have to pay every month until you repay your loan.
This system is quite hassle free, because you have to contribute only what you can afford, and not use up your entire savings or income towards repaying your loan.
Your equated monthly installment or emi is composed of two main components:
Before we try to understand how this works, let us familiarize ourselves with some of the commonly used terms in relation to emi.
Principal amount: the original value of the borrowed amount.
Interest Rate: an annually charged rate by the bank
Tenure: The duration within which the loan needs to be repaid.
Processing Fee: a small percentage of your loan amount (less than 3%) which is towards the bank’s efforts for processing the loan application.
In the initial period of repayment, your interest will constitute a major portion of your emi whereas towards the end of your loan tenure, your interest will count towards zero and your emi will majorly consist of the principal amount.
For instance, if you are borrowing a personal loan of 5 lakh value,
for tenure of 3 years at an interest rate of 15%, your emi will be 17,333.
In the first month, you will pay 11,083 as principal and 6250 as interest.
Similarly, towards the end of the tenure, you will be paying 17,119 as principal and 214 towards interest.
The difference between flat and diminishing interest rates
Now, you would have used an emi calculator to get an approximate estimate about
the value of emi payable every month. This is usually a flat rate of interest
i.e. the rate of interest rate is not going to change over the tenure;
naturally your emi will also stay the same for each month.
However, if you have chosen a diminishing rate scheme, then this means that your interest rate will be calculated based on the current loan outstanding at a particular point during the tenure. Naturally, once the interest rate reduces, so will the emi. In fact, a diminishing rate of interest gives more avenues to save up on exorbitant interest charges.
If you have taken a housing loan, then you would have come across another term called floating rate, this interest rate will change depending on the market, it is not necessary that the there should be an increase all the time, there are also chances of the interest rate reducing. Keep a window of 1% to 3% variation from the current rate. When you take this into account and calculate your emi, you will be in a better position to get an overall idea of how much would you be required to pay now, and how much you might have to pay should there be a change in the interest rate.
Apart from the change in interest rates, when you avail part-payment or pre-closure facilities you may have to pay a separate charge for the same. You may also include these charges when you use the emi calculator.