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.

How interest and tenure determine the EMI
An equated monthly instalment (EMI) is the general mode of repayment of home loans. EMIs are the fixed instalments a borrower needs to pay over the tenure of the loan in order to repay the loan as well the related interest for the period to the bank. The loan amount plus the interest for the loan tenure divided by the tenure (in months) gives you the EMI.

The amount of EMI is decided upfront, in advance, and usually remains so during the currency of the loan. The amount of EMI to be paid depends on the amount of loan, tenure of loan, rate of interest, and mode of calculation of interest. Longer the tenure, lower is the EMI. Shorter the duration, higher is the EMI. But at the same time, it is to be noted that in case of longer duration loans, during the initial period, the interest component is more and the principal component is less. Over the years, it gets reversed, and the principal component becomes more while the interest element becomes less. This is because, in the initial phase, the loan amount outstanding is more as compared to the later period.

The shorter the tenure, lower the interest rate because of the reduced risk the bank takes. Because of the shorter tenure, the EMI is higher as the loan and interest are to be repaid over a shorter time span. The longer the tenure, higher the interest rate because of the increased risk the bank takes. However, the EMI is lower because the loan and interest are spread over a longer span of time.

Depending on the present and future income and expenditure levels, you can choose an appropriate loan tenure. The income of the borrower is also important. This means both the present as well as the expected future income of the person. A borrower should be able to pay his EMIs without compromising on his standard of living.

The age of the borrower is important in this case. In case you decide to borrow at an early age, you can opt for the longer tenure loans, where the EMIs would be lower. Although the amount of interest paid would be higher as compared to the other options, you can have the benefit of availing the loan for a longer period of time. However, if you are borrowing at the later years of life, you may have to opt for a shorter tenure.

Home loan borrowers have experienced a rollercoaster ride of highs and lows over the past few years. The interest rates hovered around six to seven percent about four years ago. Until a few weeks ago, they had touched 13-14 percent. Today, some banks offer a modest eight percent home loan interest rate. The fluctuations in interest rates have an impact on a borrower's EMI dues and loan tenure.

Scenario 1: When rates go up

Increase in the interest rates translates into greater burden on the borrower. The borrower has to pay more from his pocket towards his home loan. When rates go up, the borrower has the option to either increase his EMI or tenure. Increase in EMI keeping tenure constant means greater cash outflow every month towards your loan. Increase in tenure keeping EMI constant amounts to increasing the number of years you'll be repaying the loan.

Scenario 2: When rates go down

A reduction in rates is good news that borrowers yearn to hear. When interest rates go down, the monthly EMI amount comes down automatically. Otherwise, the borrower can keep the EMI constant and bring down his loan tenure. This way he will be free of debt sooner.

Scenario 3: When you switch

When a borrower switches from fixed to floating, or vice versa, the EMI and loan tenure depends on the principal outstanding. The new rate of interest applicable after you pay the conversion fee also determines the quantum of loan. The borrower could fix at a higher rate or float at the prevailing market rate. It is up to the borrower to adjust the EMI or tenure of the loan to his convenience.

Here we compares a short and long tenure loan to analyse the impact of tax benefits

The repayment of housing loans is through equated monthly instalments (EMIs). Some banks provide an accelerating or step-up EMI facility to borrowers. The step-up EMI facility intends to reduce the repayment burden in the initial years and helps in increasing the loan eligibility of the borrower. The facility helps young borrowers particularly. They prefer borrowing early but at the same time do not have high incomes and can't afford higher EMIs in the initial years. However, over time, as their income increases, they can afford to pay higher EMIs.

In this facility, the EMI portion is recovered in parts. During the first few years, a lower EMI is to be paid by the borrower. During the latter part of the loan tenure, the EMIs are increased, so that a higher EMI is payable during the later years. This way the burden of repayment in the initial years is reduced for the borrower.

The step-up facility involves a lower outgo in the initial periods. Borrowers who are likely to earn more in future can avail this facility to get higher loans and adjust their cash flows over a period of time. In this process, the borrower takes on a higher interest rate risk if the loan is based on a floating rate of interest. A rise in rates would mean that a portion of the interest would remain unrealised and added to the borrower's principal.

Since a large part of the initial instalments go towards interest payments, the borrower can avail of tax benefits for a longer period. Interest on the loan is a cost. However, tax benefits reduce the cost of borrowing. This way the borrower can deploy his savings in other investment schemes.

The principal repayment under the step-up loan may start immediately, thereby reducing the interest rate risk for the borrower. In other cases, the EMIs for the first few years are just enough to cover the current interest rate. The process of step-up can be in different phases. In some cases, two phases are offered - one at a lower rate and the other at a higher rate. In other cases, the step-up can be a gradual process. It can be done yearly, every five years or some other frequency. Some banks also offer the step-up facility with a fixed interest rate, but the rate of interest on such loans is higher than that on a floating rate loan.

The borrowers need to understand that in the step-up facility, the interest rate risk exposure is quite high. In the initial years, the interest component is more and the principal component is less - lower EMIs in the initial years would mean that lesser of the principal is being repaid. This deferral of principal to the later part of the loan tenure will increase the interest cost of the loan. This may turn out to be costly in case of a floating rate loan where the interest rate increases. The higher interest rate would have to be paid on a higher outstanding principal loan amount. In case of a rise in interest rates, the difference is recovered through higher EMIs towards the end of the loan tenure.

How a home loan’s tenure, interest amount and EMI are linked? Here is how....
The repayment of a loan taken to buy a house is made through EMIs (equated monthly instalments). EMIs are the fixed instalments which a borrower needs to pay over the tenure of the loan to repay the debt as well the related interest for the period to the bank.

Usually, the EMIs remain constant over the tenure of the loan. The loan amount plus the interest for the loan tenure, divided by the tenure of the loan (in months) gives you the EMI. The amount of EMI to be paid depends on and varies with the amount of loan, tenure of loan, and rate of interest. One of the important parameters governing the EMI is the tenure of the loan. Nowadays, you can avail loans for various tenures - between five and 20 years, and in a few cases upto 25 years as well.

Arriving at tenure

Here are two most significant factors that determine tenure:

1) Age: If you decide to borrow early, you can opt for a longer tenure loan - 15 to 25 years. This way, your monthly EMI payment would be less. Although the amount of interest paid would be higher as compared to other options, you can have the benefit of availing the loan for a longer period of time. However, if you are borrowing towards the end of your career, you may have to opt for a shorter tenure.

2) Income: This means both the present as well as the future income. You should be able to repay his EMIs without compromising drastically on your quality of living. The cash flows available after payment of EMIs should not entail a dent in the living standards. As such, a judicious planning of cash flows is required.

Tenure and interest

The longer the tenure, higher will be the interest rate. This is because of the increased risk the bank has to take. Also, the interest amount in absolute terms is higher, because of the longer tenure. However, the EMI is lower because the loan and interest are spread over a longer span of time.

The shorter the tenure, lower will be the interest rate. This is because of the relatively lower level of risk the bank takes. Also, the interest amount in absolute terms is lesser, because of the shorter tenure. However, the EMI is higher because the loan and interest are to be repaid over a shorter span of time.

Tax benefits

You should try to avail the maximum tax benefits available under the Income Tax Act. Presently, interest upto Rs 1.5 lakhs per annum paid on housing loans is deductible from the taxable income of a borrower. You should structure the housing loan amount and tenure so that your annual interest component paid in the near future is Rs 1.5 lakhs per annum. Of course, this would be contingent on other factors as well, like your annual income and savings potential.

When does EMI change?

In case of a pure fixed loan, the EMI due to the lender remains constant. In case of a floating rate loan, the EMI moves up or down depending on the bank's benchmark lending rate. When a lender increases the interest rate, either the tenure of the loan is increased (and EMI kept constant) or EMI is increased (and tenure kept constant).

Some banks offer their customers flexible repayment options. Here the EMIs are unequal. In step-up loans, the EMI is low initially and increases as years roll by. In step-down loans, EMI is high initially and decreases as years roll by. Stepup option is convenient for borrowers who are in the beginning of their careers and hold a tremendous growth potential. Step-down loan option is useful for borrowers who are close to their retirement years and currently make good money.

What determines EMI?

Banks arrive at EMI based on:

• Total amount borrowed,
• Tenure of the loan,
• Rate of interest and
• Computation method.

When a borrower takes a larger loan, his EMI outflow is bigger. In the current scenario of volatile rate fluctuations, it is prudent for borrowers to make as much down payment as possible. Thus, they must borrow as little as possible. EMIs are heavily tilted towards interest repayments during the initial years.

What is monthly reducing method?

Borrowers benefit more from a loan that's calculated on a monthly reducing basis than on an annual basis. In case of monthly rests, interest is computed on the outstanding principal balance for that month. The principal paid is deducted from the opening principal outstanding balance to arrive at the opening principal for the next month. In case of annual rests, principal paid is adjusted only at the end of the year. Hence, you continue to pay interest on a portion of the principal that has been paid back to the lender.

How does tenure affect cost of loan?

Longer the tenure of the loan, lesser will be your monthly EMI outflow. Shorter tenures mean greater EMI burden, but your debt clears faster. Borrowers who are in a debt trap generally increase their loan tenure. This way, their EMI burden comes down. But longer tenures can drain larger interest towards the loan and make it expensive.

What is amortisation schedule?

This is a table that gives details of the periodic principal and interest payments on a loan and the amount outstanding at any point of time. It also shows the gradual decrease of the loan balance until it reaches zero.