How EMI is Calculated (Reducing Balance Formula)
The monthly installment for reducing balance loans is calculated using a standard compound interest formula, balancing out principal repayments and decreasing interest charges exactly:
Where:
- P = Principal Loan Amount (the raw amount you borrow)
- r = Monthly Interest Rate (calculated as Annual Rate / 12 / 100)
- n = Monthly Tenure count (number of monthly installments)
Step-by-Step Example Calculation
Let's take a hypothetical loan of ₹10,00,000 (10 Lakhs) at an annual interest rate of 8.5% with a tenure of 15 years (180 months):
- P = ₹10,00,000
- r = 8.5% / 12 / 100 = 0.007083 per month
- n = 15 years × 12 months = 180 installments
Plugging the numbers into the mathematical formula:
Over the full term, you repay a total of ₹17,72,537. Out of this, ₹10,00,000 represents the borrowed principal, and ₹7,72,537 is the accumulated interest paid to the lender.
Frequently Asked Questions
An Equated Monthly Installment (EMI) is a fixed payment amount made by a borrower to a lender at a specified date each calendar month. EMIs are used to pay off both interest and principal each month so that over a specified number of years, the loan is paid off in full.
In a flat interest rate, the interest is calculated on the entire principal borrowing amount throughout the tenure, making it much more expensive. In a reducing balance rate, the interest is calculated only on the remaining outstanding principal amount, meaning interest payments decrease over time as you pay off the principal.
Yes. Prepaying a portion of your outstanding loan principal reduces your remaining balance. This allows you to either reduce your future monthly EMI installment amount or shorten your remaining loan repayment tenure.
Monthly Amortization Schedule
| Month | Opening Balance | EMI Payment | Principal Paid | Interest Paid | Closing Balance |
|---|