Bite-size EMI payment does not let you feel the burden of a heavy expense as it gets auto-transferred from your bank account. However, it can drain you out of your wealth while making the lender rich. It is significant to know everything before taking loans. Being informed will make you empowered to manage your debt in a better way.
It is one thing that helps us to fulfil our aspirations when we think we can’t afford them. It enables us to go a notch higher for our home, car, mobile phones, high-end electronic item, and every other item that comes with a big-ticket price tag. At times we might detest it but we can’t refrain from reaching out to fulfil both our wants and needs. If you have not yet guessed what I am talking about – it’s none other than Equated Monthly Instalment or EMI.
EMI payment has become an inevitable and integral part of our money management. And hence, it is significant to understand all the nitty-gritty about it. It will make you feel more empowered. And next time you opt for financing any of your purchases, you can be better placed for bargaining instead of complacently nodding to all the terms and conditions put forth by the financer. Here, we are going to discuss everything you need to know about EMIs.
What is Equated Monthly Instalment (EMI)?
As explained in Investopedia, an equated monthly instalment (EMI) is a fixed amount that a borrower pays to the lender on a fixed date of the calendar month. The EMI amount includes both the principal amount and interest in a way that the entire principal and interest gets paid off within a fixed period.
EMIs are opted to ease out major expenses such as home loans, auto loans, and education loans where paying out the full amount at one go becomes a burden. In such situations, EMIs come as a reliever for both merchant and customer. The borrower agrees upon a fixed amount and tenure to pay off the loan with interest and goes ahead with his financial planning accordingly.
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How EMIs changed our lives?
Many years ago, loans were considered to be a better-to-avoid-as-much-as-possible financial aid. Particularly for personal aspirations, it was a big ‘no-no.’ Yet, major causes such as starting a business, house construction or renovation, medical emergencies, weddings, etc., were considered permissible reasons that could justify taking loans. Slowly, auto loans came into being followed by other easy-to-avail loans that helped fulfil every big and small personal aspiration.
A tad bit more expensive than personal loans that required a lot of paperwork, these loans were hassle-free to obtain and the entire amount broken into bite-size EMIs to be paid every month did not even pinch too much. Add to this the instant EMI calculator that is available on every banking website makes it even easier to eradicate apprehensions in the minds of potential borrowers. And thus EMIs have become such an integral part of our lives.
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How does EMIs work?
EMIs work on three basic components – the principal amount, the interest, and the tenure.
The EMI primarily depends upon and is directly proportional to the principal amount that has been borrowed which means that higher loan amounts invite bigger EMIs and vice versa.
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EMI Interest Rate
The other significant factor that impacts the size of EMIs is the interest rate. Interest rates differ from lender to lender. It also depends on the repayment capacity, past credit history, and income of the borrower as well as the market conditions at the time of taking the loan.
One of the biggest differentiators is the type of interest rate that the borrower is opting for. Coming to the types of interest, there are –
Reducing Rate – The rate of interest is calculated on the outstanding amount and gets reduced as the principal amount gets paid.
Floating Rates – In floating loans, the economic conditions influence the rate of interest, tenure of the loan and the EMI payment may differ accordingly. The rate of interest is revised every quarter followed by changes in the base rate executed by RBI. Floating rates are fine when the base rate remains unaffected. However, at times they may be unpredictable as well. It is always better to avoid these.
Fixed Interest Rates – In this, the rate of interest and tenor is decided at the time of borrowing the money and remains unchanged. Fixed interest rates are usually 1-2% higher than the floating rates. This is more preferred as it gives a certain idea about the EMI amount.
Progressive EMIs – Progressive EMIs are the types where the EMI amount increases after a stipulated period. This helps to clear the loan faster.
No Cost EMI – It is surprising how the very mention of no-cost EMIs help in quick conversion of sale particularly on e-commerce website and applications. Now there are options of making a purchase using your credit-card/debit-card on No Cost EMI. However, it would be a big eye-opener to learn that as per the RBI guidelines, there is no provision for zero cost or no cost EMI. The interest rates of these EMIs can be much higher than the other types. Most of the time, either it is the discounted amount on the MRP that is included in the EMIs or the processing fee is very high. Either way, the ‘no cost’ claim is just eyewash.
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Tenure of the Loan
The repayment tenure plays a significant role in deciding the EMI. The longer the tenure, the lower the EMI amount but the higher the interest payout and vice-versa.
When the tenure is long, the interest rate is higher at the initial phase and the principal amount is lower. Slowly as the payout progresses towards the completion, the principal amount increases and the interest rates go down. In the case of shorter tenures, it is just the reverse.
Tenure of the loan is decided considering the age, credit history, and scope for future income. It is easier to get loans with longer tenure if the borrower is young. However, borrowers in a more advanced age bracket are advised to opt for a shorter tenure.
All Said and Done…
It is significant to remember that at the end of the day paying EMIs is a liability that you can’t escape. Many financial experts advise against taking loans. Make sure that the reason is compelling enough and evaluate all the aspects as discussed in this article before you plunge into another EMI.
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Q. Which is the most advisable mode of paying EMIs – manually or through bank transfer?
A. Mostly all EMIs are paid through pre-approved, automated bank transfer. It saves a lot of time that is spent on paying the EMI manually and is also the most secure way of repayment.
Q. Is it advisable to make a down payment?
A. For certain purchases such as home or car, a stipulated percentage of the total cost is fixed as a down payment while the rest can be paid through EMI. Making a down payment reduces the principal amount that brings down the EMI amount and tenure, thereby reducing the loan burden. Hence, it is always advisable to make a sizeable down payment if possible.
Q. Why is it that young people get loans faster than the elderly?
A. Precisely, loans are given after evaluating your earning capacities at the time of taking the loan as well as the prospect for the future. Hence, a young professional has a better repayment capacity than a person who is mid-way into his/her career.