How to Calculate EMI of Bank Loan

Getting a loan is a very common thing in life. Loans are available for almost all your needs.

From home to a variety of items such as a TV, loans are also available for laptops. With the help of the loan, you can buy these items immediately. You pay only a small part of the total cost of the item.

You can pay the remaining amount through loans offered by consumer finance companies. These companies allow you to repay the loan within a given time period. These companies divide this amount into equal parts and distribute them in smaller amounts.

This part has to be paid every month. This is called EMI, or equated monthly installments. However, very few people know how the bank calculates this EMI. Let us try to understand how to calculate EMI.

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Here are some points to understand EMI:

1. Equated Monthly Installment

EMI is a fixed amount of money that you have to pay to the bank every month until your loan is over. The entire loan amount is called the principal.

The bank charges interest on the principal amount borrowed. This principle is used to calculate the EMI.

2. What is Included in the EMI?

Each EMI consists of some amount of principal and some amount of interest. So whenever you pay installments of EMI, the principal and interest also reduce over time.

3. Monthly Interest, Not Annual

Each EMI is calculated based on the interest rate for the month. Interest is calculated as a percentage of your principal.

This percentage is called the interest rate. Generally, the bank calculates the interest on an annual basis.

For example, with an interest rate of 8%, the interest charges come to 0.66% per month. It is very easy to calculate. Divide the annual interest rate by the number of months in a year (12 months). You will get the monthly rate.

4. Loan Tenure

EMI is paid per month. So for the calculation, your loan is considered on a monthly basis. Hence, the number of months during which you have to repay the loan along with interest is mandatory. For example, if the loan is taken out for seven years, the number of months will be 84.

5. EMI Calculation

Now that we have all the required information, the EMI can now be calculated. There are two ways: one is to use an Excel sheet, and in the second way, the calculations get a bit complicated. Excel is easy to understand.

In Excel, you can use the PMT tool. Open a new sheet, go to the Formulas section of the menu, and choose PMT from the financial formula.

You will be asked to enter some data. Enter the monthly rate (nper) or enter the number of months for which you have to repay the loan, and enter the principal amount in the PV section.

Enter “0” in the FV section and select the option “Pay at the end of the period.” That’s all.  Excel will tell you the monthly EMI.

6. Things to Remember

The interest rate is expressed in percentages. So whenever you enter the data, divide it by 100. For example, if the interest rate is 8%, then in Excel you would write 0.08 and not 8.

Secondly, whenever you pay the loan, do it at the end of the month. Hence, we have chosen the “Pay at the end of the period” option. This is important; otherwise, your EMI calculation will go wrong.

7. Example

You take a loan of Rs 10 lakh from a bank to buy a car. The bank charges interest at the rate of 8% per annum for seven years. In this case, your principal amount is Rs. 10,00,000.

The rate of interest will be 0.66% per month, and the number of months will be 84. Hence, you will have to pay an EMI of Rs 15,546.39 per month for the loan.

8. Understand How EMI Works

Each EMI consists of principal and interest. The interest payment in the first month will be the monthly interest rate of 0.66% plus the total principal amount. It will be Rs. 6,600.

This means that out of Rs 15,546.39 of EMI, Rs 8,946.39 will go towards the principal amount. Hence, you still have to repay the principal amount of Rs. Now the percentage of interest for the next month will be charged on this amount.

Therefore, the amount of interest in the second month will be Rs. 6,540.95. The remaining amount of EMI will be the principal amount of Rs 9,005.44.

This reduces your principal. In this way, the interest component of the EMI gets reduced, and the principal amount taken by you from the bank also gets reduced. However, the EMI per month remains the same.