EMI Calculation Process Explained!

So, you Applied for a Home Loan to purchase your own house. You have received the sanction letter of your Home Loan for 30 Lakhs. The terms of repayment are as follows:

Sanctioned amount – 30 Lakhs

Rate of interest – 9% per annum on a floating rate basis

Loan tenure – 20 years

EMI (Equated Monthly Instalment) – 26,992

You start wondering as to how the bank has calculated the EMI amount. You do a rough calculation of the interest payable by you over the entire tenure. It comes to around 34.78 Lakhs. It roughly translates to 5.79% (simple interest) on the amount of 30 Lakhs for 20 years. However, your sanction letter states that the rate of interest applicable is 9%.

Is it a confusing matter? No, in fact, it is not. You should be aware of the following factors that influence the calculation of the EMI:

• Banks do not follow the simple interest calculation method. They compound the interest. In simple terms, banks charge interest on the interest amount. However, they follow the reducing balance method.
• The reducing balance method ensures that your interest component reduces every month.
• The EMI comprises two components, the interest component, and the principal component.
• Banks provide you with an amortisation chart providing details of the bifurcation of the principal and the interest amounts every month. Study the chart You will notice that the interest portion reduces every month. At the same time, the principal repayment component increases gradually.

Consider the same situation listed out at the beginning of this article. This table should make things clear.

You notice that the principal component increases gradually while the interest component goes on decreasing. It is because the banks charge interest on a daily reducing balance.

This example will help you understand the EMI concept.

Do you want to verify whether you bank has done the correct calculation of the EMI? You can confirm the same in two ways. We shall discuss both the methods to make it clear to you.

The Excel Sheet Method

Now, everyone is conversant with MS Excel. You can perform a variety of mathematical calculations using Excel. The EMI calculation is also one of them. It is a straightforward calculation that will not take you even a minute to do.

• Open a spreadsheet and click on any of the cells in it
• Click the ∑ symbol and choose “More Functions”
• Select the function PMT
• Enter the rate as a number (9% divided by 12 = 0.0075)
• Enter number of instalments – Nper = 240
• Enter the value of your loan – Pv = 30 Lakhs
• You get the solution in red colour. It entails the outflow of funds from your account. In the present case, it will show a figure of 26,991.78. This amount is your EMI amount. Banks round it off to 26,992.

b) The Manual Method

You might not have access to MS Excel every time. The manual method of calculating EMI should prove handy on such occasions.

The formula is as follows.

EMI = [P x R x (1+R)^N]/ [(1+R)^N-1]

P = the principal amount of the loan (in the present case30 Lakhs)

R = Rate of interest per month (0.09/12 = 0.0075)

N = Number of instalments (240)

Insert the variables at the appropriate places,and you get the answer 26,992 (after rounding off the decimals).

Now, we suppose the EMI Calculation Process is clear to you.

Using these two verification methods, you can confirm that the bank has projected the correct amount as EMI.

What Will Happen if You Have a Moratorium Period on Loan?

Yes, Home Loans usually come with a moratorium period of 18 months to allow the construction to be complete before the commencement of the EMI. Under such circumstances, banks follow either of the following two methods of EMI calculations:

• Calculate the interest on a monthly for 18 months and stipulate the condition of paying a pre-EMI amount every month. It ensures that your principal amount remains at the sanctioned amount at the start of the regular EMIs. Subsequently, they follow the standard method of EMI calculation.
• Alternatively, they add the interest for 18 months to the principal amount and arrive at a new EMI figure. Note that, this EMI will be higher than the amount calculated by the method described above.