Educational Article • 4 min read
What is EMI?
An **Equated Monthly Installment (EMI)** is a set payment amount made by a borrower to a lender at a scheduled date each month. EMIs are applied to both interest and principal each month so that over a specified number of years, the loan is paid off in full.
How EMIs are Structured
When you pay an EMI, it does not get split equally down the middle. Rather, the payment is split between the interest charged by the lender and the principal repayment:
- Interest Portion: In the beginning months, because your outstanding principal is high, most of your EMI pays off interest.
- Principal Portion: As the months go by, you pay down the principal balance. Because subsequent interest is calculated on a lower principal balance, the interest charge drops, allowing a larger percentage of your EMI to pay down the remaining principal.
The Mathematical Formula
To calculate EMI manually, use the reducing balance method formula:
EMI = [P × R × (1+R)^N] / [(1+R)^N - 1]
Where P stands for Principal loan amount, R is the monthly interest rate, and N is the total monthly installments.
Reducing Rate vs. Flat Rate
Always check how the lender calculates interest:
- Reducing Balance Rate: Interest is calculated only on the remaining principal. As you pay off principal, interest charges drop. This is the standard, cheaper option.
- Flat Interest Rate: Interest is calculated on the full initial loan amount throughout the term. You pay the same interest amount in month 120 as you did in month 1. This makes the loan far more expensive.
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