What is EMI and how is it calculated?

EMI stands for equated monthly instalment. It is the fixed amount you pay each month to repay a loan, and it stays the same for the whole tenure on a fixed-rate loan.

Each instalment has two parts. At the start most of it pays interest; over time more of it reduces the amount you owe.

EMI = P × r × (1 + r)^n ÷ ((1 + r)^n − 1), where P is the loan amount, r is the monthly interest rate (the annual rate divided by 12 and by 100) and n is the number of months.

A loan of 500,000 at 9.5% a year over 5 years has r = 0.0079167 and n = 60, giving an EMI of about 10,501. The total payment is about 630,062, so the interest is about 130,062.

Stretching the same loan over 10 years lowers the EMI to about 6,470, but the total interest rises to about 276,000, more than double. A longer tenure eases the monthly burden but costs more overall.

Choose the shortest tenure whose EMI you can pay comfortably. Part-prepayments reduce the outstanding balance and save interest.

With a reducing-balance rate, interest is charged on the amount still owed, which is what the EMI formula assumes. With a flat rate, interest is charged on the original amount for the full term, so the real cost is much higher than the quoted figure.

When you compare offers, ask which method is used and look at the total payment, not only the rate. Fees and insurance can also be added to the loan.