Equated monthly installment (EMI) is an unequal combination of principal and interest due to the lender every month. During the initial years of loan repayment, a bulk of EMI goes towards interest repayments. Towards the end of the repayment tenure, it is more of the principal that is being repaid, and not interest amount.

How amount of EMI is determined

There are three parameters that directly impact your EMI outflow. The total loan amount, tenure of loan and rate of interest charged. The more the money you borrow, larger will be your EMI outflow. Hence, it is always advised to borrow as little as possible and avoid defaulting.

Shorter the tenure of the loan, greater will be the EMI due every month. If the tenure of the loan is short, the borrower will be debtfree sooner and is a good option in uncertain or volatile conditions. A borrower's monthly EMI outflow comes down significantly, in case of a longer tenure. However, long tenure loans are associated with higher cost of borrowing.

The higher the rate of interest, higher will be the EMI. Hence, home buyers shop for lenders who offer a low rate of interest for their home loan.

EMI and prepayment

In the initial years of the loan tenure, a major portion of the EMI goes into servicing debt. In other words, the borrower's contribution towards the interest component is very high and principal repayments are low. Since prepayment penalty is a percentage of the principal outstanding, early prepayment could cost you more in terms of prepayment penalty.

Before deciding to prepay your loan, take into account the tax benefit you could be losing. Further, weigh the consequences of repaying ahead of schedule.

Flat rate and reducing balance

The method of EMI computation can impact the EMI a bank levies on you. When the EMI is computed on a flat rate basis, the interest rate on the loan amount is calculated over the full duration of the loan. It does not matter how much you have repaid. A flat rate loan is higher because it does not take into account principal repaid.

In case of reducing balance, interest computation is made on the loan amount outstanding. In case of annual rest, principal repayments are accounted only at the end of the year. In case of monthly rests, the principal on which interest is charged goes down every month. The borrower is most benefited by interest computation on daily reducing balance method.

Bargain for low EMI

If you are paying double digit interest rate, perhaps you must explore the switch option. Many lenders are offering close to eight percent interest rate to new borrowers. You can always negotiate for a lower rate. An unblemished repayment record, no history of defaulting and a stable income level will work in your favour. It is always advisable to stay out of further debts if you find it difficult to make EMI repayments.