An Equated Monthly Installment, also called EMI, is a fixed amount paid by a debtor to a lender on a given date each month. Before applying for a personal loan, you must calculate your EMI first.
There are two ways of calculating your loan EMI – using the reducing-balance method or the flat-rate method. Both use the principal amount of the loan, interest rate, and loan term to calculate the EMI.
How to Calculate the Flat-Rate Method
The flat-rate method is used to obtain the fixed EMI. This method calculates the interest of the principal loan amount over its term, so the interest rate remains unchanged and does not decrease. As a result, your original loan amount reduces with your monthly EMI.
For example, suppose you obtain a $10,000 loan with a 5% yearly interest rate over a two-year term. You can expect to pay a total interest amount of $1,000 throughout the period with these figures.
It will cost you $27.78 per month. So, the EMI for your $10,000 loan will be $458.33 [($10,000 + $1,000)/24]. So, the payment to the principal of each EMI will be $430.55 ($458.33 – $27.78). It accounts for 85 percent of each EMI, with the interest payment accounting for the remaining 15%.
To successfully calculate your EMI, you must know the interest rate offered by the lender beforehand. You must also check your local loan guidelines to understand how much interest your lender of quick cash loans is allowed to impose on you.
Each state has its respective guidelines when it comes to loan interest rates. For instance, if you apply for loans in Chicago, Illinois, you should not be charged more than 36%. It’s one of the states where consumer loans are capped at 36%.
How to Calculate the Reducing-Balance Method
The reducing-balance method is used to calculate the diminishing balance of your loan. In addition, this method will compute the interest rate of your loan according to the outstanding balance of your principal loan amount.
Your principal loan amount and interest rate will change over time. So, as you repay the loan, your interest rate gradually decreases, and the larger portion goes towards your principal amount.
The EMI can be calculated by using this formula:
A= Pxr(1+r)n/(1+r)n -1
- A is the periodic EMI amount
- P is the principal amount of the loan
- r is the periodic yearly interest rate (Yearly interest rate divided by 12)
- n is the total number of payments which can be equal to the number of months during the loan term.
The Easy Way
If you think manually calculating your EMI is confusing, you can opt to use an online EMI calculator. Lenders typically have EMI calculators on their websites to provide customers with easy access to this information.
Using the lender’s EMI calculator will also help you decide which lender can provide you with the best loan term before consulting them.
The Importance of Knowing Your EMI
It’s advised that every individual who plans to apply for a loan should calculate their EMI. It will help you in several ways, such as:
You Can Have an Idea of How Much You Can Afford to Borrow
The first advantage you will get is that you will know if you can afford to pay a specific amount. Calculating your loan EMI in advance will help you decide on an amount that fits your budget.
You can adjust the numbers when you calculate your EMI to arrive at the best suitable amount. You should try various amounts to know how much you should borrow to help yourself with your financial needs without adding more burden to your finances.
You Can Plan Your Repayment
After knowing how much you can borrow based on the loan’s interest rate, you can adjust the loan term as per your financial needs. Choose a loan term that you can comfortably bear.
Calculating your EMI will help you schedule and plan out your repayment according to your capacity to pay the loan. Remember, the longer the term, the shorter the monthly repayment amount you will pay. However, it would be best if you also considered that you would be paying higher interest rates over time.
Helps You Plan Prepayment
Calculating your EMI will help you not only plan your repayment but also with your prepayment. With this, you can adjust your budget before even acquiring the loan. You can also start saving money and use it to pay off your loan early in the future.
When you acquire a loan, you should shop for the lender that can offer you the best loan term. Before signing a loan agreement, the first step you must take is to calculate the projected EMI of the loan you plan to acquire. This way, you can compare the options and choose the one that suits you best.