Hello,

Guest!

How do Banks Calculate EMI of a Personal Loan?

Updated on: 14 Dec 2021 // 23 min read // Personal Loans
Author :(523 posts)
image

When you take a Personal Loan or any other credit facility for that matter, your lender typically charges you a percentage of fees on the loan amount and tenure. This fee is known as the interest rate. The interest rate, combined with the original principal that you ought to repay on a monthly basis makes up the EMI, or Equated Monthly Instalment. On the basis of your loan agreement, you will be required to pay the EMI, month after month, on a stipulated date, till the end of the loan tenure.

Apply for Best Personal Loan Online

Components of EMI

As you may have come to understand by now, your Personal Loan EMI largely depends on three distinct aspects, each of which is explained below –

  • Principal

It is the actual amount that you borrow as Personal Loan and has a direct impact on the monthly instalment. The higher the principal, the larger will be the EMI.

  • Interest Rate

It is the cost of borrowing the Principal.  In a vast majority of cases, the interest rate is determined by your credit history and your ability to repay the amount.  While there is an alternative of fixed or floating interest rates for more substantial credits such as Home Loan. A Personal Loan generally attracts a fixed rate of interest. Here again, the higher the rate, the more is the EMI.

  • Tenure

It is the time span over which the borrower agrees to settle the loan. The higher the tenure of the loan, the lower is the EMI. However, you must remember that an increase in tenure also leads to a spike in the overall interest outgo.

Calculation of EMI by Banks

As far as banks are concerned, whether you opt for SBI Personal Loan or a loan from any other financial institution, they all calculate the EMI for any Personal Loan through the below-mentioned formula –

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

Here,

P denotes the Principal or your loan amount

R denotes the Rate of interest

N denotes the Tenure of the Loan (in number of months)

As you may have come to understand by now, your EMI essentially comprises of two components – Principal Amount and Interest.

In the early stages of your repayment period, the Interest component is higher while as the tenure progresses, the Principal Component takes the lead. Hence, when you approach the end of the tenure, your EMI will primarily comprise of the principal component.

Calculation of EMI by You

We understand that the above formula may seem somewhat complicated to you. It is for this reason that we suggest using a Personal Loan EMI Calculator for this purpose. You can conveniently find such a calculator online, or at the official website of MyMoneyMantra.com.

Once you identify a reliable Personal Loan EMI Calculator, all you need to do is to input three important details –

  • The Desired Loan Amount
  • The Optimal Tenure
  • The Expected Rate of Interest

As soon as you enter this information, the calculator will instantly offer you with the results which include –

  • Your EMI
  • Your Overall Interest Outgo (throughout the loan tenure)
  • The Total Payable Amount (Principal + Interest)

The results will also be complemented with a pie-chart which will help you get a sneak-peek on the proportion of the Principal Amount with respect to the Interest Payable.

How to Use EMI Calculator to Your Benefit

As a rule of thumb, most banks and other lenders prefer to give away loans only to those individuals who have an ideal debt to income ratio. This implies that your total EMI outgo should be 40% or less than your monthly income so that you can use the remaining 60% of your income towards living expenses as well as any unforeseen costs. 

Hence, if your EMI Calculator shows that your expected EMI exceed 40% of your monthly income, you can choose to implement one or more of the following measures to bring the instalment down to an optimal level.

1. Decrease your Loan Amount

This is one of the most promising ways to reduce your EMI. To this end, you can tap other sources such as borrowing small amounts of money from one or more friends or relatives, thus subsequently reducing the principal you need to borrow from the bank. Besides, you can also double-check your actual need, and if possible go for an intrinsically lower loan amount.

2. Increase your Tenure

Yet another way of reducing your EMI is increasing your Personal Loan tenure by 1 or 2 years. This will help spread the principal component, thus ensuring that your EMI is reduced significantly. In this case, however, you must understand that your overall interest outgo will increase, thus making the loan a little expensive for you.

3. Lower the Interest Rate

Of course, this isn’t something that you can control. You can, however, make sure that you have a high credit score when you apply for the loan. Besides, you can shop around and analyse the Personal Loans offered by various banks and online lenders to identify the loan with the lowest rate of interest. A difference in the rate of even 1 to 2% can help you enjoy a comparatively lower EMI.

Knowing how banks calculate Personal Loan EMIs can help you compare the deals more efficiently and realistically.

Also Read: 5 Tips to Manage Personal Loan EMIs

To apply online for Credit Cards, Secured Loans and Unsecured Loans, visit www.mymoneymantra.com, the leading online lending marketplace that offers financial products from 70+ Banks and NBFCs. We have served 2 million+ happy customers since 1989.

Apply for a Personal Loan