A monthly instalment is easy to compare with your income. The total amount you will pay over the whole loan is harder to see, and it is usually much larger than people expect. This article walks through the arithmetic with a fictional loan so you can do it for your own.
The EMI formula
An equated monthly instalment (EMI) is fixed, and covers both interest and principal. The formula is:
EMI = P × r × (1 + r)ⁿ ÷ [(1 + r)ⁿ − 1]
where P is the loan amount, r is the monthly interest rate (annual rate ÷ 12 ÷ 100) and n is the number of monthly instalments.
An illustrative loan
Suppose someone borrows ₹50 lakh at an assumed 8.5% a year for 20 years (240 months). The monthly rate is about 0.7083%. The EMI works out to roughly ₹43,400. Over 240 months, the total paid is about ₹1.04 crore. The interest component is therefore about ₹54 lakh, a little more than the amount borrowed.
Why the early years are mostly interest
Interest each month is charged on the outstanding balance. At the start, the balance is the full ₹50 lakh, so the first month’s interest is about ₹35,400 and only about ₹8,000 of the EMI reduces the principal. Years later, the balance is smaller, interest is smaller, and more of each EMI repays principal. The split changes gradually, which is why a year-by-year table is more instructive than a single total.
What a shorter tenure does
Keep the same loan and rate but make the tenure 15 years (180 months). The EMI rises to about ₹49,200, which is around ₹5,800 more each month. But total interest falls to roughly ₹38.6 lakh, about ₹15 lakh less. A higher instalment can mean a considerably lower total cost.
Questions worth asking before borrowing
- What is the rate, and is it fixed or floating? A floating rate can change the EMI or the tenure.
- Are there processing fees or prepayment charges?
- What share of your monthly income will the EMI take? Many people set a personal limit.
- How would a missed instalment or a rate change affect you?
What a part-prepayment does
Continue with the same loan. After five years of EMIs of about ₹43,400, the outstanding balance is roughly ₹44.1 lakh. Suppose the borrower pays an extra ₹5 lakh towards principal at that point. The balance drops to about ₹39.1 lakh, and the interest charged each month falls by about ₹3,500 (₹5 lakh × 0.7083%). If the EMI stays the same, the loan ends sooner. If the lender reduces the EMI instead, the monthly outgo falls and the tenure stays the same. Which of the two applies depends on the lender’s terms, so ask.
Floating rates change the picture
Many home loans carry floating rates linked to an external benchmark. If the rate moves, lenders typically adjust either the EMI or the tenure. When rates rise and the EMI is held, the tenure can lengthen, sometimes by years, and more of each instalment goes to interest. It is worth checking the current outstanding tenure from time to time, since the figure on the original sanction letter may no longer apply.
Other costs to include
- Processing fee, usually a percentage of the loan.
- Insurance, if the lender bundles it.
- Prepayment or foreclosure charges, which vary by loan type and borrower category.
- Stamp duty and registration if the loan relates to a property purchase.
None of these appears in the EMI formula, so they have to be added to your own estimate of the total cost.
A worksheet for your own loan
Write down the loan amount, the rate, and the tenure in months. Compute the EMI. Multiply by the number of months for the total paid, then subtract the amount borrowed to see total interest. Then repeat with a tenure five years shorter and a rate one percentage point higher. Seeing four scenarios side by side usually tells you more than any single figure.
What the numbers cannot say
Arithmetic shows cost. It does not say whether a loan is a good idea. That depends on income stability, other commitments, the purpose of the loan and what alternatives exist. A lower total interest cost is not automatically better if the higher EMI would strain the household budget. Equally, a lower EMI that stretches over a long tenure may be sensible for someone who expects to prepay when they can.
It is reasonable to keep the numbers and the decision separate: use the arithmetic to understand the cost, and use your own circumstances to decide.
These are questions of arithmetic and personal circumstances; none of this is a recommendation to borrow or not to borrow. To see the year-by-year split for your own figures, you can use a calculator that shows how much interest a loan adds over its tenure.
The figures above are illustrations with assumed rates. Real loan terms vary by lender and borrower, so use the numbers in your own loan agreement. The same site has free calculators for loans, growth and inflation if you want to run related sums.
