Know your EMI's in-and-out. Are you paying more than you should?

Our one-stop primer covers the basic facts about EMIs, ideal practices, and how to structure them irrespective of the kind of loan you’re availing.

An EMI stands for Equated Monthly Instalments, and is the unit in which one repays any kind of loan they have availed; it is composed of principle repayment and interest. The proportions of these 2 components varies over time as the tenure of your loan advances.

An EMI is arrived at by adding the total principle borrowed and the interest due thereon for the entire duration of the loan and then dividing the sum by the number of months in your selected tenure.

Even if you don’t increase your EMI pay-out over time – which you can- you should at least leave it intact over the tenure of your loan. Should other factors change - like the rate of interest being charged by your lender, or a pre-payment made by you – opt instead to have your tenure adjusted accordingly, rather than reducing your EMI.

Related: Types of loans [infographic]

Since credit is now a way of life for the average Indian versus the emergency measure it used to be a couple of generations back, it’s best to be aware of where the traps lie and how to use loans prudently and develop a sound personal finance game plan. Let’s go!

Source: CCILINDIA

• First things first... Take credit because it’s necessary. Not because it’s convenient.
  • Don’t fall into the habit of buying small appliances on EMIs just because they’re on offer.
  • Your final pay-out will be more than the market value of the appliance; so, if you can afford it, buy it outright.
  • Appliances and cars are fast depreciating assets; ideally, at no point should the value of the asset drop to less than the balance outstanding on your loan.
  • And with high-end cell phones, if you lose your phone, you’ll be paying EMIs on something you no longer possess!
• Remember that all credit comes at a cost (interest/fees)
  
• Read the fine print for all fees, and the system of penalties on prepayment and EMI lapse

• Related: Debit card vs credit card [infographic]

• Most loans, even though their EMIs remain the same through the loan tenure, the interest pay-out is much higher in the earlier EMIs of a payment schedule.
• The simple diagram below illustrates this point

• As one repays the principal amount, the interest part starts reducing while principal component increases.
• So, it makes sense to prepay at the beginning of the loan tenure than later in the payment schedule. i.e. As you pay off your loan, the outstanding principal reduces and the interest is charged on the outstanding balance.

• Longer tenures cost you more in interest pay-out.
  • Especially, if you’re a salaried person, opt for as short a tenure as you can manage now, the EMI will become a lesser proportion of your salary with every pay hike.

• All your EMIs ought to ideally total under half of your gross monthly income to allow you to comfortably pay them without feeling a pinch in managing your other outflows.
• Finally, talk to the experts.
  • Whether you engage an advisor or talk to a friend or a relative,get their viewpoint on the state of your EMIs and their recommendations.
  • Set a period of every 3 years or 5 years to review your financial track.