EMI Types and Calculation

You take a loan and expect to repay it in monthly installments spread over a period of time. The installment includes principal as well as interest components and it is known as the equated monthly installment or EMI. EMI is calculated considering the loan amount, interest rate and duration of loan. Some lenders consider interest on the entire loan amount regardless of the principal amount reducing as you go on paying. This makes the loan expensive. If you have taken a loan of Rs. 100000 for three years, you will pay the agreed rate of interest for three years. Most banks follow the reducing method. The interest amount is the major portion and the principal amount the minor portion in the EMIs you pay in the initial stages. As you keep on paying the principal amount increases and interest amount decreases, interest being calculated progressively on the reducing amount of principal.

EMI Calculation Formula

EMI = (Loan Amount x interest) x (1+interest) ^n/ [(1+interest) ^n]-1
Where interest = (rate in percent)/12; n=loan period in months.

When the bank sanctions a loan, you can prepare an excel worksheet with this formula and tally it with the EMI amount just to make sure there are no hidden components. Each lending institution usually has an online EMI calculator but it cannot give you a clear picture of the entire tenure as an excel worksheet does. By maintaining a worksheet you have a clear idea of the exact amounts of interest and principal and this can help in tax computations.

Types of EMI
In principle, EMI is the same but you may want to differentiate it into three segments. These could be classified as Accelerated Repayment, Pre-EMI, and Tranche based EMI.

Accelerated Repayment
EMI amounts are fixed over certain tenure, the variables being the principal and interest components combining into a fixed amount. If you anticipate career growth and increased earnings, you can opt for the accelerated repayment scheme offered by banks. As you progress you can opt to go in for a higher EMI amount and thus accelerate repayment of your loan and benefit by paying lesser interest.

Pre-EMI
If you have a loan for a house under construction, the lender will not disburse the full loan amount but will release it in proportion to the progress of construction. In such instances repayment does not start with commencement of pro-rata releases of funds to the builder but only when the full amount has been disbursed. If it takes a year or two for construction to be completed, you stand to benefit in that you only pay interest on the partial amounts in the form of pre-EMI.

Tranche Based EMI
When you are granted a loan for a house under construction, you can enter into specific arrangements with the bank for disbursal of part amounts as construction progresses and to fix the installment amount until the house is ready. The installment can include interest and principal but you have the option of paying only the interest amount as a bare minimum. The interest, here, would normally be computed on the loan amount and, in this method, could lead to faster repayment. Smart home buyers opt to start repayment of the full EMI despite only a part disbursal as a way to reduce tenure and burden. This is the tranche based EMI system.

Regular repayment of EMIs can establish a positive track record and you can renegotiate EMIs with lowered interest rates or, if you get a better offer from another bank, transfer the loan. Even a nominal rate difference is worth the effort, time and expense to make the switch. Switching banks also lets you get additional loan factoring in the current market value of your property.