What is EMI and How is it Calculated?

January 18, 2025

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Imagine standing at the showroom, eyeing the latest scooter or a brand-new car. The excitement is real, but so is the hefty price tag. Paying the full amount upfront feels overwhelming, but there's a solution that bridges the gap between desire and affordability—Equated Monthly Instalments (EMIs). This financial tool has empowered millions of Indians to own their dream vehicles, homes, and gadgets without straining their savings.

According to the Reserve Bank of India (RBI), household credit in India surged by 17% year-on-year in 2024, driven largely by consumer loans for vehicles, homes, and personal needs. With rising aspirations and easy access to credit, EMIs have become an essential part of everyday financial planning.

What is EMI Full Form and Meaning?

EMI stands for Equated Monthly Instalment. Let’s say you have taken a home loan of ₹10 lakh for a tenure of 10 years. You have to repay the amount to the bank in EMIs, meaning every month a fixed amount would be deducted from your linked bank account until the loan is fully repaid. Each EMI consists of two components:

Principal Amount: The original loan amount.
Interest Amount: The cost charged by the lender for borrowing the money.

Over the loan tenure, the interest portion decreases while the principal repayment increases. This structure is known as the reducing balance method, which is widely used for most loans in India. EMIs offer a predictable repayment structure, helping you manage large expenses—such as buying a home, bike, card, or even funding education—without depleting your savings.

How is Loan EMI Calculated?

EMI is calculated based on the loan amount, interest rate, and tenure. Adjusting these parameters would either reduce or increase your loan EMI. Please note that the loan processing fee is not a part of your EMI.

Banks and financial institutions calculate interest on loans using three common methods: daily reducing balance, monthly reducing balance, and annual reducing balance. Each method impacts how quickly the loan principal reduces, influencing the total interest paid over the loan tenure.

1. Daily Reducing Balance Method (Most Efficient for Borrowers)

In the daily reducing balance method, the outstanding loan principal decreases daily as you make payments. Interest is calculated on the remaining principal every day, making this method highly borrower-friendly, especially for large loans like home loans.

How It Works:

When you pay your EMI, the principal reduces immediately.
Any partial prepayments made during the month instantly lower the outstanding principal, leading to lower interest charges for the remaining loan.

Example:

If your EMI is due on the 5th of every month and you make a prepayment on the 10th, the principal reduces on the 10th itself.
As a result, from the 10th onward, interest is charged on the lower principal, saving you money.

This method is widely used by banks for home loans and large personal loans, as it minimizes the overall interest burden.

2. Monthly Reducing Balance Method

In the monthly reducing balance method, the principal is reduced once a month, after the EMI is paid.

Example:

If you make a prepayment on the 10th, it won’t reflect until the next EMI date (e.g., the 5th of the following month).
This delay results in slightly higher interest payments compared to the daily reducing method.

Housing finance companies often use this method, but it is less efficient than the daily reducing balance method.

3. Annual Reducing Balance Method

In the annual reducing balance method, the principal reduces only once a year, after EMI payments for the entire year.

This outdated method results in significantly higher interest payments and is rarely used today.

What is Loan Amortization Schedule?

A loan amortization schedule details how each EMI is split between principal and interest, along with the outstanding principal after every payment. It helps you track your repayment progress over the loan tenure.

Loan EMI Calculation Formula

The formula to calculate EMI is: EMI=(1+R)N−1P×R×(1+R)N

Where:

P = Loan principal
R = Monthly interest rate (annual rate/12)
N = Total number of monthly instalments

For example, a ₹50 lakh loan at a 10% interest rate over 20 years results in an EMI of approximately ₹48,251.

This structured repayment helps borrowers manage large loans effectively while minimizing interest through methods like the daily reducing balance. However, manual calculations can be taxing and may leave room for errors. As a better alternative, use our Home Loan EMI Calculator. Ujjivan’s EMI Calculator is extremely easy to use. All you need to do is select the loan amount, tenure and applicable interest rate. The EMI Calculator would show your EMI amount. You can also separately check the principal and interest amount.

Can You Increase Your EMI After Taking a Loan?

You can increase your EMI or reduce the loan tenure by writing to the bank. You may require a few documents (generally forms) to submit, including your desired loan tenure or EMI amount. Increasing your EMI or lowering your loan tenure can help you reduce the interest component, lower the total cost of the loan and close your loan faster.

Loan Amount	Tenure	Interest Rate	EMI	Total Interest Paid
₹10 lakh	15 years	8.75% p.a.	₹9,934	₹7,99,007
₹10 lakh	10 years	8.75% p.a.	₹12,532	₹5,03,921

As you can see, though the EMI is higher, you would end up saving approximately ₹3 lakh on interest.

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FAQs

The reducing balance method and the flat rate method are two common ways of calculating EMI. Under the reducing balance method, interest is calculated on the outstanding loan balance, which decreases as you make EMI payments. This means that over time, as the loan balance reduces, the interest component of each EMI also decreases. In contrast, the flat rate method calculates interest on the entire principal amount for the entire loan tenure, regardless of the outstanding balance. While the reducing balance method is more cost-effective for the borrower, the flat rate method often results in higher overall interest payments.

Missing an EMI payment can have serious consequences. First, lenders typically impose a late fee or penalty for missed payments. This fee adds to the total amount you owe and can make it harder to catch up on payments. Additionally, missing payments impacts your credit score. A poor payment record negatively affects your credit rating, which can make it difficult to secure future loans or lead to higher interest rates. If EMIs are consistently missed, lenders may take legal action to recover the dues or even foreclose the loan.

Yes, it is possible to increase your EMI, but it requires the bank's approval. Increasing the EMI will result in paying off the loan faster, which can save you money on interest in the long run. This is because the quicker you reduce the principal, the less interest you will be charged. However, it is important to ensure that the higher EMI fits within your monthly budget. Before requesting an increase, make sure you can afford the new payment amount without straining your finances.

Timely EMI payments can have a positive impact on your credit score, as they demonstrate your ability to manage debt responsibly. Regular payments reflect financial discipline, which is essential for building a strong credit history. Conversely, missed or delayed EMI payments can severely affect your credit score. A low credit score can hinder your ability to borrow money in the future or may result in higher interest rates on loans.

The decision depends on your financial situation. A shorter loan tenure with higher EMIs means that you will pay off the loan faster, reducing the overall interest cost. While the monthly payments are higher, you’ll be free of debt sooner and save money in the long run. On the other hand, choosing a longer tenure with a lower EMI reduces your monthly financial burden but increases the total interest paid over the life of the loan. If you can afford the higher EMI without financial strain, a shorter tenure is typically the better option to save on interest.

Prepayment refers to making an additional payment towards your loan before the due date, which reduces the outstanding principal. If you make a partial prepayment, your lender may adjust your EMI downward, keeping the loan tenure the same, or it could shorten the tenure while keeping the EMI the same. Either way, prepayment helps reduce the interest paid over the course of the loan because interest is calculated on the reduced principal. Prepaying your loan when possible can lead to significant savings in the long term.

Typically, you cannot switch between repayment methods, such as from monthly reducing balance to daily reducing balance, after the loan has been sanctioned. Loan terms are fixed at the beginning, and any changes would require a new agreement. However, if you’re unhappy with the EMI method, you can explore options like refinancing your loan or prepaying to reduce the principal faster. It’s always a good idea to check with your lender to understand the options available for changing your loan terms.