When you apply for a loan, regardless of whether it is a personal loan, a home loan or a car loan, the second most important thing (the first is the interest rate) to consider is your monthly payment. It is called the equalized monthly installment since it is the same amount that you will have to pay every month until you repay your loan. This system is fairly hassle free as you contribute only what you can afford and not use all of your savings or income to pay off your loan.
Your equal or emi monthly fee is made up of two main components:
- principal amount
- Interest rate
Before we try to understand how this works, let’s familiarize ourselves with some of the commonly used terms in relation to emi.
– Principal amount: the original value of the amount borrowed.
– Interest rate: a fee charged annually by the bank
– Tenure: The duration within which the loan must be repaid.
– processing fee: A small percentage of your loan amount (less than 3%) that goes towards the bank’s efforts to process the loan application.
In the initial repayment period, your interest will make up a major portion of your emi, while towards the end of your loan term, your interest will count toward zero and your emi will consist primarily of the principal amount.
For example, if you are borrowing a personal loan worth 5 lakhs, for a period of 3 years at an interest rate of 15%, your emi will be 17,333. In the first month you will pay 11,083 principal and 6,250 interest. Similarly, towards the end of the tenure, you will pay 17,119 as principal and 214 as interest.
The Difference Between Fixed and Declining Rates
Now, you would have used an emi calculator to get a rough estimate of the value of emi payable each month. This is usually a fixed interest rate that is, the interest rate will not change during the tenure; Naturally, your EMI will also stay the same each month.
However, if you have chosen a decreasing rate scheme, then this means that your interest rate will be calculated based on the current loan outstanding at a given point in time during the tenure. Naturally, once interest drops, so will your emi. In fact, a falling interest rate gives you more chance to save on exorbitant interest charges.
If you have taken out a home loan then you would have come across another term called variable interest rate, this will change depending on the market, there need not be an increase all the time, there are also chances that the interest rate will decrease. Maintain a window of 1% to 3% variation of the current rate. When you take this into account and calculate your emi, you will be in a better position to get a general idea of how much you would have to pay now and how much you would have to pay if there was a change.
Apart from the change in interest rates, when you make use of partial payment facilities or pre-closing, you may have to pay a separate charge for them. You can also include these charges when using the emi calculator.