Financial Planning Essentials

Usage

EMI stands for Equated Monthly Installment. It is a fixed payment that a borrower makes to the lender at a specified date each month. An EMI is used to pay off both the principal amount and the interest on a loan. The amount of the EMI depends on the loan amount, the interest rate, and the loan term.

The formula to calculate the EMI on a loan is:

EMI = [P x R x (1+R)^N]/[(1+R)^N-1], where:

• P = Principal amount of the loan
• R = Rate of interest per month (annual rate of interest divided by 12)
• N = Number of installments (loan term in months)

The interest component of the EMI is calculated based on the outstanding balance of the loan, and the interest rate charged by the lender. At the beginning of the loan tenure, the outstanding balance is the full loan amount. As the borrower continues to make EMI payments, the outstanding balance decreases, and so does the interest component of the EMI.

The principal component of the EMI is calculated as the difference between the total EMI amount and the interest component. As the borrower continues to make EMI payments, the principal component of the EMI increases, and the interest component decreases, until the entire loan amount is paid off.

Tax Benefits: Some loans allow partial principal and full interest deduction while some allow only interest to be deducted. These deductions help you reduce your taxable income and hence you pay lower taxes. Understanding the principal and interest components helps in claiming appropriate tax deductions.