Loans
A loan is one formula and three decisions: how much, how long, and what to do with a surplus.
A loan is one formula and three decisions. The formula is the reducing-balance annuity that produces the EMI, and it is public — every lender in the country runs it, so any instalment you are quoted can be checked in thirty seconds. The decisions are how much to borrow, over how long, and what to do with any surplus once the loan is running.
Of the three, tenure is the one most consistently underestimated. It is presented as an affordability lever, which it is, and its effect on total cost is enormous: on a twenty-year home loan the interest can exceed the amount borrowed, and stretching to thirty years adds substantially more. None of that appears in the monthly figure, which is the number the conversation is usually conducted in.
The third decision — prepay or invest — has no universal answer, and this topic is explicit about that. Against high-rate debt the arithmetic is decisive. Against a single-digit home loan it is close enough that liquidity and temperament legitimately decide it.
Key terms
- EMI
- The equated monthly instalment: the fixed payment that clears a loan over its term. Produced by the annuity payment formula from principal, monthly rate and number of months, and identical across lenders using reducing-balance interest.
- Reducing balance
- Interest charged each period on the outstanding balance rather than on the original principal. Standard for Indian home, vehicle and personal loans, and the reason the interest share of an EMI falls over the life of the loan.
- Amortisation schedule
- The month-by-month breakdown of an EMI into interest and principal. Reading it is what makes the cost of tenure and the value of early prepayment visible, both of which are invisible in the instalment alone.
- Prepayment
- Paying more than the contractual instalment to reduce principal early. Returns the loan's interest rate, guaranteed and untaxed, and saves most when made early — at the cost of being irreversible.
Frequently asked questions
How is an EMI calculated?
EMI = P × i × (1+i)^n / ((1+i)^n − 1), where P is the principal, i the monthly rate (annual divided by twelve) and n the number of months. Every reducing-balance loan calculator runs this. Working it once for your own loan is the cheapest way to verify that a quoted instalment matches the rate and tenure you were told.
What tenure should I choose?
The shortest one whose instalment you could still service in a bad month — a period of reduced income, a large unexpected expense, one earner between jobs. Longer than that costs a great deal in total interest; shorter than that risks a default on a secured asset, which is a far worse outcome than paying more interest.
Is it better to prepay or invest a surplus?
Prepay anything above roughly twelve per cent without further analysis, because no portfolio reliably beats it and the return is guaranteed. Below that, compare the loan rate — adjusted for any tax deduction — against your expected post-tax return, and treat a gap of under two percentage points as a tie to be settled on liquidity rather than arithmetic.
Do prepayment charges make it not worth it?
Check your loan agreement, because the position differs by loan type and by whether the rate is floating or fixed. Where a charge applies, include it in the comparison: a one-off fee against years of avoided interest usually still favours prepaying, but the arithmetic is worth doing rather than assuming in either direction.