Loans are an integral part of our lives today. They help achieve some important financial goals which would otherwise not be possible. Be it funding your child’s future education or arranging money for marriage, paying for your dream home or that much wanted car. Whatever the need be, there is a Loan for every purpose. There are important terminologies associated with every loan. “EMI” is one such common term.

Loans are repaid in Equated Monthly Instalments (EMIs). Every month a stipulated amount is deducted from your monthly salary towards repayment of your debts. EMIs can either be paid through auto-debit instructions set up on salary accounts or the borrower can send cheques every month. In either scenario, the amount to be paid back is the same, month on month, for the entire Tenure. This amount is officially referred to as EMI.

**How EMI is calculated?**

Primarily there are three factors that are taken into account when computing an EMI. They are:

- Amount of Loan – This the total amount of money borrowed. In some cases, the loan may be sanctioned for a larger limit however, only a part of it is used so the EMI is calculated not on the sanction limit but on the amount of money actually borrowed.

- Interest Rate – This is the rate of interest that will be charged by the lending institution on the sum lent. The interest is calculated on reducing balance.

- Loan Tenure – This refers to the entire period for which the loan has been granted. The tenure in months is used for calculation purposes. Alternatively, this can also be called the number of instalments due.

EMI is calculated as below:

EMI = | P * r * (1+r)^{n}/ (1+r)^{(n-1)} |

where,

P = Principal or Amount borrowed

r = Rate of interest per annum

n = number of instalments.

Thankfully in this age of technology you do not have to indulge in manual calculations. You can make use of online __loan EMI calculators__ to instantly arrive at a possible EMI. Given the calculation above, it is aptly clear that EMIs are directly proportional to interest rate and principal amount, while it is inversely proportional to the loan tenure. In simple words, higher the amount borrowed or higher the rate of interest, the EMI will be higher too. However, longer the tenure, smaller will be the EMI.

For example:

For a personal loan of 1,00,000 at the rate of 12% for 12 months, the EMI would be = 8884/-. For a personal loan of same amount for the same tenure but at rate of 15%, the EMI would be = 9025/-. For a personal loan of 2,00,000 at the rate of 12% for 12 months would yield an EMI of 17,769/-. Whereas, for a loan of 1,00,000 at the rate of 12% for 36 months would spell into an EMI of 3321/-.

Thus you can see how your EMI changes with a change in any of the three primary factors.

**Why Calculating EMI is so important?**

A lot of people are extremely enthusiastic about getting financed. While they plan extensively on what to do with the funds received, they often go underprepared from the debt-repayment perspective. Knowing what your EMI would be before you have applied for a loan would enable you to budget your monthly expenses accordingly.

People who have calculated their EMIs are prepared for what they are getting into, plan for how their lives will be impacted post the EMI and deal better with the burden of debt-repayments than those who don’t plan enough. Goes without saying, the difference of better planning often shows in better credit scores.

Comparing EMIs on loan offers by different lenders guides borrowers to better deals.

EMIs are calculated in such a fashion that with every instalment, a part of the principal and a part of the interest is repaid. Interestingly, and contrary to popular customer belief, during the initial phase of the loan tenure, a larger portion of the EMI is allocated towards repayment of interest. Practically after half the tenure has passed, a larger fraction of the EMI is accounted towards principal.

More of this can be made clear through an Amortization Schedule. This is an important table that shows the break-up of your EMI into interest and principal components, month on month. You can either request for an amortization schedule from the bank you apply to or you can calculate the same using online __loan interest calculator__. This is another important document you must go through before signing any documents.

**Why does the EMI change over the tenure?**

Incase during the loan tenure, there is a change in any of the three variables that go into the calculation of the EMI, then the EMI might change. Some of the common reasons are:

- Borrower prepays the loan – this means the principal amount will fall and therefore the interest calculated on the balance amount will change too. This will bring the EMI down.

- Interest rate change – If your loan is based on flexible rate of interest then the EMI will be adjusted to account for the change in interest rate.

- Borrower requests for restructuring of loan and an increase in loan tenure. This is will mean a lower EMI.

**Summing-Up**

Since computation of EMI is made easy with the help of online EMI calculators, every person hoping to take an advance must make use of it. It helps in calculating your affordability by helping you understand on what will your left over disposable income ultimately. This in turn helps you to avoid poor credit.

EMI varies with loan tenure and interest rate. Amortization schedule helps the borrower see how much outstanding balance is left. It is especially helpful when the loanee wants to foreclose or prepay the loan. The bottom line of any loan is the EMI. Knowing the EMI keeps the borrower from hitting the bottom.

The post Why Should You Use EMI Calculator Before Applying For A Loan? appeared first on Credit Sudhaar Blog.

*This post first appeared on Credit Sudhaar Blog - Tips To Improve Your Credit, please read the originial post: here*