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Published by Learntrix··6 min read
How Loan EMI is Calculated: The Reducing Balance Formula
An Equated Monthly Installment (EMI) represents an annuity payment that distributes principal repayment and interest charges across uniform monthly installments.
1. The Universal Reducing-Balance Formula
Banking institutions calculate EMI using the standard monthly annuity formula:
EMI = P × r × (1 + r)ⁿ ÷ ((1 + r)ⁿ - 1)
Where P is Principal loan amount, r is Monthly interest rate (Annual rate / 12 / 100), and n is Total tenure in months.
2. How Amortization Evolves Over Time
In the initial months of a long-term loan (such as a 20-year home loan), interest constitutes over 70% of each EMI payment. As the principal is gradually repaid, the monthly interest portion decreases while the principal repayment share accelerates.