How EMI is calculated, step by step
Your instalment is the same every month. What it is made of changes completely from the first month to the last, and understanding that is what tells you when prepaying is worth it.
The formula
Every bank in India uses the reducing balance method. Interest each month is charged on what you still owe, not on the original amount, and the instalment is set so that the loan clears exactly at the end of the term.
Three inputs.
- P is the principal, the amount you borrow.
- r is the monthly interest rate. Take the annual rate, divide by 12, then divide by 100. So 8.75 percent a year is 0.0072917 a month.
- n is the number of monthly instalments. A 20 year loan is 240.
Working it through
Borrow ₹25,00,000 at 8.75 percent for 20 years.
- r = 8.75 ÷ 12 ÷ 100 = 0.0072917
- n = 240
- (1 + r)n = 1.0072917240 = 5.7177
- Numerator = 25,00,000 × 0.0072917 × 5.7177 = 1,04,229
- Denominator = 5.7177 − 1 = 4.7177
- EMI = 1,04,229 ÷ 4.7177 = ₹22,093
Over 240 months you pay ₹53,02,264. You borrowed ₹25,00,000, so ₹28,02,264 is interest. The interest is larger than the loan.
What is inside each instalment
This is the part that changes everything about how you think about a loan. The EMI is fixed, but the split between interest and principal shifts month by month.
In month one you owe the full ₹25,00,000. Interest for that month is 25,00,000 × 0.0072917 = ₹18,229. Your EMI is ₹22,093, so only ₹3,864 goes towards the principal. That is 17 percent of your payment reducing the debt and 83 percent disappearing as interest.
| Month | Interest | Principal | Balance after |
|---|---|---|---|
| 1 | ₹18,229 | ₹3,864 | ₹24,96,136 |
| 60 | ₹16,161 | ₹5,931 | ₹22,10,496 |
| 120 | ₹12,921 | ₹9,172 | ₹17,62,813 |
| 180 | ₹7,909 | ₹14,183 | ₹10,70,530 |
| 240 | ₹160 | ₹21,933 | ₹0 |
Halfway through the term, after ten years and ₹26,51,160 paid, you still owe ₹17,62,813 of the original ₹25,00,000. You have paid more than the loan amount and cleared less than a third of the debt. Nothing has gone wrong. That is how amortisation works, and it is worth seeing before you sign rather than discovering at year ten.
Why this makes early prepayment so effective
A prepayment reduces the outstanding principal, and every future month's interest is calculated on that reduced figure. So the value of a prepayment depends entirely on how much interest is still ahead of it.
Put ₹2,00,000 in at the end of year two on the loan above and you save roughly ₹6,37,000 in interest, cutting three years off the term. Put the same ₹2,00,000 in at year fifteen and you save roughly ₹95,500. Same money, nearly seven times the effect, purely because of when.
The practical implication is that a bonus in year two is worth far more against your loan than a bonus in year twelve. If you are going to prepay at all, front load it.
Reduce the EMI or reduce the tenure
After a prepayment most banks ask which you want. Reducing the tenure keeps your monthly payment the same and clears the loan sooner, which saves substantially more interest. Reducing the EMI gives you monthly breathing room and saves much less.
Neither is wrong. Just know that "reduce my EMI" is the more expensive choice, and choose it deliberately rather than by default.
What the formula does not include
The EMI is calculated on the loan amount. It does not include the processing fee, documentation charges, legal and valuation fees, or any insurance bundled into the deal. Together these commonly add one to two percent of the loan value, which on ₹25,00,000 is ₹25,000 to ₹50,000 paid at the start.
Always ask for the total amount payable including all charges, in writing. A lender offering a slightly lower rate with a higher fee can easily be the more expensive option, and comparing headline rates alone will not show it.
Floating rates, and the thing banks do quietly
Most home loans in India are floating, tied to an external benchmark such as the repo rate. When the benchmark rises, your bank has two options: raise your EMI, or extend your tenure and keep the EMI the same.
Most choose the second, because nobody complains about an unchanged EMI. But extending the tenure adds interest, sometimes a great deal of it. A one percent rate rise handled by tenure extension on a 20 year loan can add several years to the term without your monthly payment moving at all.
Ask your lender which they adjust, and after any rate change ask for the revised amortisation schedule. If they extend your tenure and you can afford the higher instalment, ask them to raise the EMI instead.
Run your own numbers
The EMI calculator gives you the instalment and the total interest for any combination. Two things worth doing with it: run your loan at a rate two percentage points higher to see what a rate rise would do, and compare your intended tenure against one five years shorter. The second comparison changes more minds than any argument.
If you are still at the stage of working out what a bank will lend you, the loan eligibility calculator works backwards from your income.
Common questions
Why is my first EMI almost all interest?
Because interest is charged on the outstanding balance, which is at its highest at the start. On a 20 year home loan at 8.75 percent, roughly 83 percent of your first instalment is interest and 17 percent reduces the debt. That ratio reverses gradually across the term.
Does prepaying early really save that much?
Yes, and the difference is large. On a ₹25,00,000 twenty year loan, ₹2,00,000 prepaid at year two saves roughly ₹6,37,000 in interest. The same amount at year fifteen saves roughly ₹95,500, because by then there is far less interest left to remove.
Should I reduce my EMI or my tenure after prepaying?
Reducing the tenure saves considerably more interest, because you keep paying the same amount against a smaller debt. Reducing the EMI helps monthly cash flow and saves much less. Choose deliberately rather than accepting whatever the bank defaults to.
Are there penalties for prepaying a home loan?
For floating rate home loans taken by individuals, the Reserve Bank of India has barred lenders from charging foreclosure or prepayment penalties. Fixed rate loans and many personal and business loans can still carry a charge, so check your agreement before prepaying a large sum.
Why did my tenure increase when rates went up?
Because your bank chose to absorb the rate rise by extending the term rather than raising your instalment. It keeps the EMI comfortable and increases the total interest you pay. If you can afford a higher EMI, ask them to adjust that instead and request the revised schedule.
Written by Khanjan Kavani, who builds software in Surat and writes these to answer the questions clients keep asking. Found a mistake? Tell me at hello@khanjankavani.com and I will correct the article itself.
General information, not professional advice. Rules in India change. Check anything important against the current position or a qualified professional. See the disclaimer.