What it means
On a reducing-balance loan, interest is charged each month on what is still owed. The EMI stays the same, so early instalments are mostly interest and later ones mostly principal. The formula:
EMI = P × r × (1 + r)^n ÷ ((1 + r)^n − 1)
where P is the loan, r the monthly rate (annual rate ÷ 12) and n the number of months.
Example
A loan of ₹1,20,000 at 11.5% a year over 12 months:
| Item | Value |
|---|---|
| Monthly rate | 0.958% |
| EMI | ₹10,634 |
| Month 1: interest / principal | ₹1,150 / ₹9,484 |
| Month 12: interest / principal | about ₹101 / ₹10,533 |
| Total interest over the year | about ₹7,600 |
A “flat” rate of 11.5% would charge interest on the full ₹1,20,000 for the whole year, ₹13,800, nearly twice as much, which is why lenders must show the annual percentage rate.
Common mistakes
- Comparing a flat rate with a reducing rate as if they were the same.
- Forgetting fees, which raise the real cost above the quoted rate.
- Starting the schedule from the sanction date instead of the disbursement date.
In MyRecords
A loan application in the Lending module works out the EMI and total interest on submit; this exact example came out at ₹10,634, with ₹7,605 of interest. The Lending home also has an EMI calculator. After disbursement the loan carries a full repayment schedule whose principal adds up to the loan and whose last balance is zero, and interest accruals, dues and repayments post to the ledger.