Understand Your EMI: Equated Monthly Installment

 

Imagining modern life without adequate finance has become impossible for many, be it be for personal, business, or for buying a house. Borrowing from a Financial Institution, or an NBFC is one of the options but it means you have to pay it back too. And that is where the concept of EMI or Equated Monthly Installment comes in. It refers to that amount of money you have to repay every month till the entire loan gets repaid. This way, you can borrow a certain amount to meet your funding needs and repay the value over a period of time, in installments. The value of EMI depends on certain parameters as described below:

Components of EMI

Every EMI has a principal component and interest component.

1. Principal Amount – It is the actual loan amount you borrow from a lender. The interest will be charged on this sum of money and it will be distributed equally over all the months included in the loan tenure.

2. Interest Amount – This component refers to the amount which you get by multiplying the interest rate with the principal amount. Interest is considered as what you pay to the lender for using its money.

3. Tenure – This is the time period calculated from the date of getting the loan amount to the date when you pay your last EMI or close the loan.

Factors That Affect EMI

1. Loan Amount – The higher your loan amount, the higher will be your EMI, depending upon the duration of the loan. It is a direct causal effect.

2. Rate of interest – This rate is calculated based on your credit score, income, and repayment capability. You are likely to be charged a lower interest rate with a higher credit score or income, as it means that you are capable of repaying the loan on time. And, a higher interest rate will obviously mean a higher interest component, and consequently a higher EMI.

3. Tenure of the loan – EMIs are lesser when your tenure is longer, on the contrary, a shorter tenure means higher EMI but you will get to repay your loan quicker.

4. Make your repayments on time – It always makes sense to unburden yourself of a loan without making defaults. So, if your income and budget plan permits, it is wise to carry on with your monthly EMIs, else you can also prepay a part of your loan, to reduce the principal outstanding amount.

Effective Ways to Reduce the Interest Amount

1. Repay high interest loans first – By paying off the most expensive loans first, you can reduce your interest burden in future. Hence, try to pay off personal loans and credit card debts first. Decide the maximum amount you can repay against the costly loan, without making the repayment of other loans problematic. Once you are sure, pay it.

2. Increase EMI annually with rise in income – When you get a raise or receive some extra cash, focus on paying off your EMI first. So, when your income rises by 10% say, increase the EMI you pay every month by a certain significant amount. If you have multiple loans, use the extra income to pay off the more expensive ones first. This will reduce your interest burden significantly.

3. Set EMI targets – Assess your monthly expenditure and savings carefully and set a target EMI amount that you are confident about paying off. Once you set a target, whether small or big, stick to it. Failing to pay even one EMI will add a certain penalty to your repayment amount and it can also set you back in terms of credit score and shoot down your chances of getting a future loan.

4. Use windfall gains to repay costly debt – If you receive a large amount in income tax refunds, a big bonus at work, or maturity proceeds from insurance policies, use it to pay off your costliest debts. Find out if you can prepay a part of the loan with it, without incurring penalty charges.

5. Convert credit card dues to EMI – Ignoring credit card dues is never prudent, especially if they are a large amount. If you keep rolling over your dues, the interest rate on the outstanding balance in a year can be quite high. So, convert your dues into EMIs, to pay back easily.

1. Use existing investments to repay debt – To get out of bad debt situations, you can use your investments. For example, you can borrow from your PPF if you are in the third financial year of investment or borrow against a life insurance policy. Borrowing against gold jewelry is another way to pay off bad debts.

7. Consolidate or refinance – Multiple loans are always tough to track, and if you miss a single EMI, your credit score will plummet. So, it is a wise move to consolidate your unsecured, expensive and smaller loans into one large loan, with a much lower rate of interest. For instance, personal loans and automotive loans can be consolidated into a single loan against property with a longer tenure and lower EMI. Consider refinancing for your home loan, if you get a better interest rate. If you have a new home loan and the rate you are paying is even slightly higher than the market rate, opt for refinancing.

Quick financing options makes life better and more convenient during challenging times and help you realize your dreams for sure. But without understanding the nuances of EMI, you might get into trouble after borrowing. So keep the above tips in mind and pay off your dues as soon as possible to maintain a good credit score and live stress-free.