Loan EMI Calculation Using Reducing Balance Amortization
An Equated Monthly Installment (EMI) is a fixed monthly payment made by a borrower to a financial institution on a specified date of each calendar month to repay both the principal loan amount and accrued interest over the loan tenure.
Mathematical Formula for EMI
EMI = [P × r × (1 + r)^n] / [(1 + r)^n - 1]
Where:
- P: Principal Loan Amount borrowed.
- r: Monthly interest rate (Annual Interest Rate divided by 12 and then by 100).
- n: Loan tenure in months (Years × 12).
Understanding the Reducing Balance Principle
In the initial years of a long-term loan (e.g. 20-year home loan), the major portion of each monthly EMI goes towards servicing interest, while a smaller portion reduces principal. As the outstanding principal gradually declines, the monthly interest portion decreases and the principal repayment component increases.