Financial institutions, from credit unions to personal loan lenders, use the acronym "EMI" in loan documents. It stands for "equated monthly installment," and represents how much you will pay on a loan each month. Here, we'll explain how EMI works and how it impacts your monthly budget.
When you take out an installment loan, whether it's a home loan, car loan, personal loan, or business loan, you agree to make a monthly payment. This payment stays the same from month to month. Because every monthly payment is equal, these payments are called "equated monthly installments." You agree to make those payments until the loan is paid in full.
An equated monthly installment (EMI) includes principal, interest, and sometimes, fees rolled into the loan by the lender.
To calculate loan EMI, you need four things:
For instance, let's imagine that you borrow $200,000 at an annual interest rate of 4% for 15 years. You pay no fees.
|Loan term||15 years|
The EMI payment breakdown looks like this:
Often, when you take out a loan, the lender adds an origination fee and various closing costs. If the lender rolls those fees into the loan, they also become part of the EMI calculation. Let's look at an example with fees.
Let's say you take out a personal loan for $15,000 at an annual interest rate of 6%. The loan term (sometimes referred to as the "loan tenure") is 60 months, and the lender rolls $300 of fees into the loan.
|Loan term||60 months|
Here's the breakdown of this EMI payment:
The official calculation for EMI is: P = L[r(1 + rn] / [(1 + r)n - 1]
While it is unlikely you will need to know the exact formula, the important thing to remember about EMI is that it is calculated by adding your principal balance to the interest paid, and dividing that total by the number of months you have to pay the loan.
Shopping around for a lender is important, because you can't always determine which loan will be least expensive by solely comparing interest rates. While the loan interest rate is important, it doesn't tell the entire story.
Fees vary widely by lender. While one lender may charge a slightly higher interest rate, that lender may offer loans with no fees. Another may advertise a lower rate, but tack on fees that mean you pay more in total.
If a lender charges $750 in fees, you don't just pay $750. When the fees are rolled into the loan, you also pay interest on that $750. Here's how much extra you'll pay:
|Fees (without interest)||$750|
|Loan term||60 months|
|Interest paid on fees alone||$120|
|Actual cost of fee (original fee + interest)||$870|
EMI tells you how much you'll pay each month if you have a fixed-rate loan. EMI also helps you create a budget with confidence that there aren't going to be any surprises.
Loan EMI gives you a lot you need to know as a borrower, from how much the interest payment will be every month to how much you will pay in total over the repayment term. In short, EMI makes you a savvier borrower. Once you know how much your monthly payments will be, you are better equipped to live with financial confidence.
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