By Dr.

Abhijit Kar Gupta:

e-mail: EMI: more or less?


If we take a loan from a bank or a financier, we have to keep certain things in mind in connection with the compound interest (that is usually considered). The most important thing is the repayment schedule. Interests are generally calculated periodically after one month or each day or sometimes every three months. The calculated interest on the principal value (the amount of loan taken) is added with the principal itself and then the repayment amount (the installment) is deducted from this sum to arrive at a balance amount. At the next step, the interest is calculated on the last balance amount and the new reducing balance amount is obtained in the same way. Balance amount = Previous balance amount + Interest on the balance amount – Repayment amount. This is the mathematics. This process is continued iteratively until the balance amount reduces to zero. And then the loan is fully repaid. If the repayment amount is to be given every month and a fixed amount is decided to be returned every month, it is termed as EMI (equated monthly installment). The period over which this repayment process will go on is naturally dependent upon the amount of EMI, (given a certain rate of interest). Conversely, the EMI can be decided if the exact number of installments for repayment is pre-decided. For a fixed interest rate, the EMI and the number of installments can be fixed once for all. For the floating interest rate, the EMI has to be decided over a projected period of repayment considering possible small revisions of interest rates. Any loan taker should first consider if the mathematics is alright. There has to be careful scrutiny of any ‘hidden’ amount or some misleading facts or factors (other than the mathematics as mentioned above) which may complicate the matter at a later stage. You can easily check the calculations which can be easily done with a hand calculator. (Else you may write a tiny computer program or indulge in some elementary algebra.) Often an odd EMI value is thrust upon you (usually an odd number, may be even a prime!) when the loan agreement process is over. Don’t worry. The amount must be greater than a minimum value (‘critical’ amount). The critical value of EMI is basically the calculated interest at each month. The payable EMI amount should definitely be greater than this critical value as the balance amount has to be kept reducing. For a loan of Rs.1 lakh (100,000) with the interest rate of 9.5%, the critical EMI is around Rs.792. Therefore, the payable amount that is to be decided should certainly be more than this amount. If now the EMI is settled to be Rs.1000, the total loan is repaid within a period of 16 years and a half. (One thus ends up in repaying Rs.1000 × 16.5 × 12 = Rs.198, 000 over the entire period.) If the EMI is decided to be Rs.800 then the loan period extends over a little more than 48 years! (In this case one ends up in repaying around Rs.800 × 48 × 12 = Rs.460, 800!) On the other hand, if the EMI is decided to be heavy, Rs.1500 for example, the loan period ends within 8 years. (The total repayment is now Rs.1500 × 8 × 12 = Rs.144, 000 only.) In the course of repayment, if the interest rate is hiked, the critical EMI amount shoots up and the payable EMI should thus be increased accordingly so as to bring down the loan period. The general principle is that our payable EMI amount should be as far away the critical amount as possible. We have to remember

By Dr. Abhijit Kar Gupta:



that more time we take to repay the loan amount means more we end up in paying. The EMI may be within our comfortable margin, but we compromise in repaying larger and larger amount in aggregate over the entire period. If we think that is a huge loss then that is to be. The mathematics clearly says that. We are only buying time with that extra amount of money that we are forced to shell out. (So clearly, time = money, ha!) The financiers or the financial advisers will perhaps all these things in mind (and what’s more) and give you some obvious tips like increasing the EMI or the time period or to pay a lump sum at some point to reduce the balance amount in a big way. However, you may play around with the simple calculation of compound interest and decide yourself!
Please feel free to contact me in case you want me to calculate.