Calculation of Home Loan EMI

There are numerous home loan schemes available in the market, currently. Home loans are designed to meet each home buyer’s need. However you need to understand the most significant constituent of a loan – EMI. EMI (Equated Monthly Installment) is a part of the loan paid to the lender on a regular basis (daily or monthly) for the purpose of buying a house or flat.

EMI:

An EMI is a monthly amount paid by the borrower to the lender in order to clear the outstanding loan amount. A specific sum of pre-decided amount is deducted from your chosen account, every month without fail. The deduction is not affected by any sudden financial constraints you may face and will continue to be carried out by the bank. The EMIs are usually deducted on a fixed date every month until the tenure of the loan is completed and the whole loan amount is repaid.

Break-up of EMI:

EMI is computed based on an unequal distribution of the principal amount and interest. In the initial phase of a home loan, majority of the EMI constitutes the interest towards the loan. As the loan reaches its maturity, over time and the principal amount gets repaid, the outstanding balance decreases. Eventually, the interest amount is lower than the principal. However, EMI remains constant every month.

In some exceptional cases, the EMI also might change. For instance, the borrower decides to pay a large portion of the outstanding loan. The additional amount is then adjusted with the outstanding balance, thereby decreasing the EMI. However, the lender gives you an option to maintain the EMI and decrease the loan tenure instead. The EMI of your home loan also fluctuates if you have chosen floating rate of interest as the EMI will vary based on fluctuations in the market.

Factors Determining Home Loan EMI:

The EMI of your home loan is determined by the following factors:

• Principal: The principal amount is the actual amount of money borrowed, while taking a loan. The loan amount is one of the most important factors when taking a loan. The EMI that is required to be paid by you towards the loan depends on the principal amount.
• Interest Rate: Rate of interest refers to the rate at which a borrower avails a loan amount from a lender or bank. The rate of interest decides the EMI that you would have to pay towards the loan. EMI of the loan is directly proportional to the rate of interest at which the loan is being offered. Higher the rate of interest, higher is the EMI. Therefore, it is best to do a detailed analysis and research on interest rates being offered by various lenders before finalising on a particular home loan.
• Tenure: Loan tenure is the duration of the home loan within which a borrower is required to make the complete repayment. You can choose the loan tenure based on your repayment capacity and comfort. However, the loan tenure is indirectly proportional to the EMI. The longer the loan tenure, lower the EMI. It simply means, the longer duration of a home loan allows you to pay your monthly EMIs without it being a burden on you.
• EMI Calculation: Computing EMI of a loan is also one of the major facts that decide whether or not the home loan is ideal or not. There are more than one ways to compute the EMI for a particular loan. They are:
• Annual reducing method – In this method, borrowers are required to pay the EMI every month. However, the interest rate and principal amount is computed at the year’s end. This type of calculation usually proves disadvantageous to borrowers as they have to keep paying the interest towards a part of the principal that has already been repaid to the bank.
• Monthly reducing method – This is an easier to understand calculation. In this method of EMI calculation, the principal amount is reduced as per monthly EMI payments. The interest is computed based on the outstanding amount of the loan. This is the most accepted and adopted method of EMI calculation among banks and lenders
• Daily reducing method – In this method of computation, the EMI is paid on a daily basis. With daily repayments, there is a reduction in the principal every day. The rate of interest is calculated on the outstanding amount. However, it is not a preferable EMI calculation method.

Mathematic Calculation of EMI:

EMIs for a home loan are calculated using the following mathematical formula:

EMI = P x r x (1+r) n/((1+r)n-1)

Where, P = Loan amount

r = Rate of interest

n = Loan Tenure (number of months)

Pre-EMI option:

Sometimes borrowers can choose to avail part disbursement of their home loan by timing it according to the stages of the house construction. In such cases, lenders require you to pay a monthly pre-EMI until the final loan disbursement. However, only after the disbursement of the entire loan amount, the loan repayment is started. The pre-EMI only constitutes the interest earned on the disbursed loan amount.

Step Up and Step Down EMI:

EMIs can sometimes be changed based on the borrower’s income. In step up EMI, there is a gradual rise in the EMI based on the increase of the borrower’s salary. In this case, the EMI charged in the initial part of the loan tenure is low and over time it increases with the expected increase in the borrower’s income. In step down EMI, the EMI gradually decreases with the repayments.

Advance Loan Disbursement:

In some cases, the entire loan amount is disbursed even before the construction of the house is complete. This is granted by the lender upon request from the borrower. The advance loan disbursement is only sanctioned when the bank or the lender trusts in the builder to complete construction on time.

Loan Amortization Schedule:

A loan amortization comprises of all information regarding the home loan availed. Information such as borrowed loan amount, scheduled payment periods, EMI break-up and outstanding balance is given in the schedule.