What is EMI: How Does it Work and How is it Calculated?

Sumeet, a graphic designer and tech enthusiast, wants the new Samsung Galaxy S23 Ultra but worries the price tag is too high. This is a common situation! You might dream of the latest phone or iPhone, but the cost can be daunting.

This is where EMIs (Equated Monthly Installments) come in. EMIs let you split a large purchase into smaller, easier-to-manage payments spread over a set time. This way, you can own the gadget you want without straining your finances.

What are EMIs?

EMI stands for Equated Monthly Instalment. It’s a fixed monthly payment that covers both the loan amount you borrow and the interest on it.

How Do EMIs Work?

EMIs make expensive purchases more affordable by breaking them down into manageable monthly payments over a specific period, usually ranging from a few months to several years. Each EMI payment has two parts:

  • Principal amount: This is the actual amount of money you borrowed.
  • Interest: This is the fee charged by the lender for borrowing the money.

Calculating EMIs involves complex formulas considering the loan amount, interest rate, and loan term. However, lenders often use online calculators to determine your EMI, so you’ll know the exact amount you’ll owe before committing to a loan.

Understanding Your EMIs with an Amortization Schedule

An amortization schedule is a table that shows how your EMIs work. It details each payment you make towards the loan and how much goes towards principal and interest. This helps you understand how your loan is getting paid off over time.

Initially, a larger portion of your EMI covers interest. As you make payments, more of your money goes towards the principal amount, and less goes towards interest. The amortization schedule will show you this breakdown.

Example: Buying a Smartphone with EMIs

Let’s say you want a Rs. 1,00,000 smartphone. Instead of paying upfront, you can spread the cost over six months with EMIs of around Rs. 17,254.84 per month.

In the first month, you might pay Rs. 1,000 in interest, and the remaining Rs. 16,254.84 goes towards the principal, reducing your loan balance to Rs. 83,745.16. This process continues until your last EMI when you’ll have paid off the loan and finally own the phone outright.

EMIs are a great way to manage your finances and afford the gadgets you want without breaking the bank.