What Is an Equated Monthly Installment?
An equated monthly installment (EMI) is a fixed payment amount made by a borrower to a lender at a specified date each calendar month. Equated monthly installments are used to pay off both interest and principal each month so that over a specified number of years, the loan is paid off in full. With most common types of loans, such as real estate mortgages, the borrower makes fixed periodic payments to the lender over the course of several years with the goal of retiring the loan.
Equated Monthly Installment
Understanding Equated Monthly Installments (EMI)
EMIs differ from variable payment plans, in which the borrower is able to pay higher payment amounts at his discretion. In EMI plans, borrowers are usually only allowed one fixed payment amount each month. The benefit of an EMI for borrowers is that they know precisely how much money they will need to pay toward their loan each month, which makes their personal budgeting process easier.
Equated Monthly Installment Formulas
The EMI could be calculated using the flat rate method or the reducing balance method. The EMI flat rate formula is calculated by summing the principal loan amount and the interest on the principal. The sum is divided by the number of periods in months.
The EMI reducing balance method is calculated using the formula:
(P x I) x ((1 + r)n)/ (t x ((1 + r)n)- 1)
in which P is equal to the principal amount borrowed, I is the annual interest rate, r is periodic monthly interest rate, n is the total number of monthly payments and t is the number of months in a year.
EMI Flat Rate Example
Assume a property investor takes out a mortgage of $500,000, which is the principal loan amount, at an interest rate of 3.50% for 10 years. Therefore, the investor's EMI using the flat rate method is calculated to be $5,625, or ($500,000 + ($500,000 x 10 x 0.035)) / (10 x 12). Note that in the EMI flat rate calculation, the principal loan amount remains constant throughout the 10-year mortgage period. Therefore, the EMI reducing balance method may be more suitable because borrowers typically pay off the monthly balance to reduce the principal.
EMI Reducing Balance Method
Assume that the EMI reducing balance method was used instead of the EMI fixed rate method in the previous example. The EMI would be $1,549, or (($500,000 x (0.035)) x (1 + (0.035 / 12))120;) / (12 x (1 + (0.035/12))120; - 1). Therefore, the EMI reducing balance method is more cost-friendly to borrowers.