How banks calculate home loan EMI; here's all you need to know

Many people have multiple loans, whether it be personal loan or home loan. Which leads to major portion of our monthly expenditure, especially for those who have a home loan. And still hardly few people know how banks calculate home loan EMI.

A home loan is an essential loan product for a customer who decides to purchase a home but does not have the sufficient funding to do so. A home loan is a specific amount which is borrowed by a customer for a tenure which is fixed from a financial institution to buy, construct or renovate a residential property.

What is Home Loan EMI? It means a fixed amount of payment that a borrower pays to a lender on a specified date every month as repayment of the home loan taken. The abbreviation of EMI is Equated Monthly Installment. Your EMI constitutes the principal as well as the interest components. During initial years, the principal component is far less than the interest part, which is calculated on the outstanding balance of the principal.

EMI = Principal amount + Interest on principal amount. This is paid through auto debit instructions to the bank or with post dated cheques.

Interest Rates

Interest rates on home loan is an amount that the bank or financial institution charges from you for taking a loan. Home loan interest rates are usually either related to repo rate or governed by Reserve Bank of India mandates.

There are three ways in which a bank can charge interest— monthly reducing, annual reducing and daily reducing balance. Banks use the daily reducing balance for home loans, while some housing finance companies use the monthly method. However, as EMI is paid monthly, there’s no difference in the effective interest rate, unless you prepay.

How is EMI calculated?

There is a common mathematical formula based on which all banks and financial institutions calculate the EMI. It is based on the principal loan amount, the rate of interest and the loan tenure.

The EMI depends on three factors—the loan amount, the rate of interest and the loan tenure. You can easily calculate the EMI using the PMT formula in Excel. For that, you’ll need three variables—the interest rate (rate), the loan period (nper) and the loan amount or the present value (PV).

Here is the formula:

EMI = [P x r x (1+r)n] / [(1+r)n-1], where P is the principal loan amount, r is the rate of interest per month and n is the number of monthly instalments.

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