How EMI is Calculated — Step-by-Step Formula Breakdown

EMI = P × r × (1+r)^n ÷ ((1+r)^n – 1)

• Where:
• P = Principal loan amount
• r = Monthly interest rate (annual rate ÷ 12 ÷ 100)
• n = Total number of monthly instalments

This is called the reducing balance method — interest is calculated on the outstanding balance, which decreases each month as you pay EMIs.

Given: P = ₹10,00,000 | Rate = 8.5% p.a. | Tenure = 5 years (60 months)

Step 1: Monthly rate r = 8.5 ÷ 12 ÷ 100 = 0.007083

Step 2: (1 + r)^n = (1.007083)^60 = 1.5266

Step 3: Numerator = P × r × (1+r)^n = 10,00,000 × 0.007083 × 1.5266 = 10,814

Step 4: Denominator = (1+r)^n – 1 = 1.5266 – 1 = 0.5266

Step 5: EMI = 10,814 ÷ 0.5266 = ₹20,543

Total payment: ₹20,543 × 60 = ₹12,32,580 Total interest: ₹12,32,580 – ₹10,00,000 = ₹2,32,580 (23.3% of loan)

In the first months, most of your EMI goes toward interest. Over time, the interest portion decreases and principal portion increases.

₹10L loan at 8.5% for 5 years (EMI ₹20,543):

Month 1: 34.5% goes to interest. Month 60: Only 0.7% goes to interest.

Some dealers and NBFCs quote flat rate instead of reducing balance. The flat rate looks lower but is actually much more expensive:

Flat rate at 8.5% = Reducing balance at ~16%! The flat rate calculates interest on the original principal for the entire tenure, ignoring that you're paying it down monthly.

Rule of thumb: Flat rate × 1.8 ≈ Reducing balance rate. So '7% flat' ≈ 12.6% reducing balance. Always ask for the reducing balance rate.

Prepaying even a small amount early in the loan dramatically reduces total interest:

₹10L loan at 8.5% for 5 years (EMI ₹20,543):

Prepaying ₹50K annually saves ₹46,280 in interest — almost the prepaid amount itself! Earlier prepayments save more because the outstanding balance is higher.