Part 1: What is an EMI?
Part 2: How EMIs are calculated
In the final part of our series on Equated Monthly Installments, we outline what you must know before taking that loan.
When arriving at the EMI, a financier will not just go by what you want. They will objectively look at your income to determine whether or not you can afford to pay the EMI.
Generally, they will not allow the EMI to go higher than 35% to 45% of your gross monthly income.
This, however, is just a broad figure. It not only depends on your income but also on how many loans you are servicing and how many dependents you have.
Let's say you are married with a working spouse and have no dependents. Your chances of a higher EMI are much better than someone who, say, does not have a working spouse but also has four dependents (spouse, child, parents).
Also, the more the number of loans you are servicing, the greater the strain on you and lesser the amount of income left with which you can pay your day-to-day expenses.
Ultimately, it depends on you. Here, we tell you how to be smart.
Don't go by percentages
Let's say you have two individuals: Anil and Jayant. Let's say Anil earns Rs 15,000 a month while Jayant earns Rs 50,000.
Thirty-five percent of Anil's salary is Rs 5,250; 35% of Jayant's salary is Rs 17,500. Anil will be left with just Rs 9,750; Jayant still has Rs 32,500.
Don't go by percentages here; look at the actual income and actual figures.
How much of an EMI are you comfortable with? Will you have to stretch too much with the balance amount? Or, will you be comfortable?
If you have to make too many sacrifices to accommodate a high EMI, you may find you can only do it in the first few months. After that, it will put too much of a strain if you cannot even afford to eat out on and off or watch a movie without carefully counting each rupee.
Moreover, if you have other loans to pay, you cannot cut down on those payments. So, look carefully at your outflow (expenses) and inflow (income) before making up your mind.
Tax benefits
If you are taking an education loan or home loan, you will get tax benefits. So, it does not matter if you stretch out these payments over time. In this way, your EMI too will be smaller.
But, if it is a personal loan or a vehicle loan -- these do not give you any tax benefits -- then don't keep the tenure (period of the loan) too long.
Salary increases
If you foresee great pay hikes in the coming years, you may not mind living on a tight budget the first year or two. Then, as your salary increases but your EMI stays constant, you will be able to comfortably repay your loan.
Opting for high EMIs makes sense if you foresee rapid or substantial increases.
Interest rates
If your loan has a high interest rate, don't dilly-dally with repayment. Clear it as soon as you can. This is especially true for personal loans, where the interest rate can go up to 21% per annum.
Let's work it out
Loan amount = Rs 1,00,000
Rate of interest = 12% per annum
1-year EMI = Rs 9,333
2-years EMI = Rs 4,931
3-years EMI = Rs 3,470
So you totally pay out Rs 1,11,996 for a one-year loan, Rs 1,18,344 for a two-year loan and Rs 1,24,920 for a three-year loan.
Finally, when looking for a loan, don't go by what interest rate a company is giving you, go by actual EMIs. Let's say two banks are offering you a home loan or personal loan. With a fixed loan amount and fixed repayment tenure, ask them what the EMI will be.
Since some calculate on a monthly reducing basis and others on an annual reducing basis, go by actual EMIs.
Or, a bank may say they will give you 35% of your income while another may say 40% of your income. Here too, ask what the EMI will be with a particular tenure and loan amount.
Only when you get an actual EMI figure will you be sure what you are getting into.
Part 1: What is an EMI?
Part 2: How EMIs are calculated
