The complete truth about EMIs: What formula do banks use to calculate them? Learn how you can reduce your burden..

Nowadays, people take out different types of loans according to their needs and repay the money to the bank through EMIs (Equated Monthly Installments). However, whenever someone considers taking out a home loan, personal loan, or car loan, the first question that comes to mind is how much the monthly EMI will be. Many people assume that banks arbitrarily decide the EMI, but the reality is quite different. In fact, banks calculate the EMI using a fixed calculation formula, in which the loan amount, interest rate, and loan tenure play a crucial role.

It's worth noting that recently, after the RBI's (Reserve Bank of India) reduction in the repo rate, people are hoping that their EMIs will decrease. Therefore, it becomes even more important to understand how EMI is calculated and what factors it depends on. So, let's learn about the formula used to calculate your EMI.

Basic Formula for EMI Calculation
Banks use this formula to calculate EMI:

EMI = P × R × (1+R)^N / [(1+R)^N – 1]

In this formula:

P stands for the principal loan amount
R stands for the monthly interest rate
N is the total loan tenure (in months)

It's important to note here that banks first convert the annual interest rate into a monthly interest rate. For example, if the annual interest rate is 7.2%, then the monthly rate is calculated by dividing it by 12 and then by 100, i.e., R = 7.2 / 12 / 100 = 0.006. Let's understand the complete EMI calculation with an example.

Let's assume a person takes a loan of ₹10 lakh for 10 years (120 months) at an interest rate of 7.2% per annum.  According to the formula:

EMI = 10,00,000 × 0.006 × (1 + 0.006)^120 / [(1 + 0.006)^120 – 1]

Based on this calculation, the person's EMI will be approximately ₹11,714 per month.

Nowadays, customers can easily perform this calculation using online EMI calculators available on bank or finance websites.

If the loan tenure increases, the EMI decreases, but…
Generally, people opt for a longer loan tenure to reduce their EMI. While it's true that a longer loan period results in a lower EMI, it also has a disadvantage: you end up paying more interest overall. Conversely, a shorter loan tenure means a slightly higher EMI, but the total interest paid is significantly less.

What to do with existing loans?
If you already have a long-term loan, choosing loan restructuring or prepayment options from your bank might be the best solution. This can reduce the loan tenure, although the EMI might increase slightly. Interest rates also depend on your credit score, loan amount, and tenure.  In short, it's crucial to choose your EMI wisely so that it doesn't put too much burden on your finances and you don't end up paying unnecessary interest.

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