Difference between EMI and Simple Interest

Equated Monthly Instalment or EMI as it is popularly known is the fixed amount a borrower pays to the lender at a predetermined date every month. EMIs are used as a payment method wherein both the interest and principal amount are paid each month, spread over a particular duration so as to pay the loan in full at the end of this time period.

Simple Interest is defined as the interest earned on a certain sum of money (principal) at a fixed interest rate and for a particular time period. It is the most basic form of calculating interest.

Formulae

Simple Interest – There are four variables involved in the calculation of Simple Interest,

P, which is the Principal Amount

T, which is the Time duration

R, which is the Interest Rate

SI, which is the simple interest

SI = PTR/100

Equated Monthly Instalments – There are different formulae one can use to calculate Equated Monthly Instalment, depending on their individual calculating abilities.

The basic formula for EMI is given by

EMI = P x R x (1 + R) N / [(1 + R) N – 1]

Where

EMI is the Equated Monthly Instalment,

P is the Principal loan amount,

R is the Interest Rate,

N is the tenure (number of months)

If Harish took a loan of Rs 100,000 at an interest of 10% per annum for a period of 1 year, then

1. The simple interest will be given as:

SI = (100,000 x 1 x 10) / 100

SI = 10,000

The total amount due after the term period is Rs 110,000, with the interest being Rs 10,000.

2. The EMI will be calculated as:

EMI = 100,000 x 10 x (11/12)2 / [(11/12)2 – 1]

EMI = 8792

The total amount paid at the end of 1 year is Rs 105,504, with the monthly instalment being Rs 8792.

Payment method

In case of Simple Interest, the total amount due is generally paid in one go, as a lump sum, whereas in case of Equated Monthly Instalments the entire amount due is calculated beforehand and this amount is equally divided into monthly amounts, due at a specified date each month.

Components of Amount

Simple Interest consists of the entire principal amount and the interest accrued during the term period.

Equated Monthly Instalment is a fixed component which consists of the interest, which is generally compounded and a part of the principal which is due. Each EMI pays a part of the interest and reduces the principal amount due till the loan is completely paid off.

Where are they used?

Simple Interest is generally used to calculate the interest on short term loans or loans which are to be paid at the end of a particular period.

Equated Monthly Instalment is used for long term loans wherein the entire amount due is split into smaller components, to be paid at equal durations.

Which payment method is better?

Both simple interest and EMIs are a popular payment option and the preferred mode of payment depends entirely on the individual concerned. EMI offers the benefits of lower overall payment and the individual also knows how much needs to be paid monthly, ensuring that he/she can plan for it appropriately, making it easier to budget personal finances.

Simple Interest on the other hand offers the benefit of having more money during the loan term as no amount is deducted monthly. This extra amount can be extremely useful for business or personal needs.