An EMI is one fixed payment that covers both interest and principal. Early in the loan most of it is interest. Towards the end most of it is principal. The instalment stays the same; what changes is the split.
The formula
EMI = P x r x (1+r)^n / ((1+r)^n - 1)
P is the amount borrowed, n is the number of months, and r is the monthly rate, which is the annual rate divided by 12 and by 100. On a loan of 5,00,000 at 11 percent for 5 years, the EMI works out to roughly 10,871 rupees a month.
Tenure cuts the EMI and raises the total cost
A longer tenure makes the monthly number look friendly, but you pay interest for more months. The same 5,00,000 at 11 percent costs about 1,52,000 in interest over 5 years. Stretch it to 7 years and the EMI falls, while the total interest rises well past 2,00,000. Pick the shortest tenure whose EMI you can pay comfortably every month, not the one that just about fits.
Flat rate is not the same as reducing balance
- Reducing balance: interest is charged on what you still owe, so it falls as you repay. Bank and NBFC loans are normally quoted this way.
- Flat rate: interest is charged on the full original amount for the whole tenure. A 10 percent flat rate is close to 18 percent in reducing balance terms.
If a lender quotes a flat rate, ask for the annual percentage rate on a reducing balance so you can compare it with other offers.
Look past the interest rate
Processing fee, documentation charges, insurance sold along with the loan and any penalty for paying early all add to the cost. Ask for the sanction letter and read the charges page. Rules on prepayment and foreclosure charges differ by lender and by loan type, and they change from time to time, so confirm what applies to your loan in writing before you sign.