How are loans calculated? A Simple Guide for First-Time Borrowers.
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If you are planning your first loan, the biggest question is simple: How are loans calculated? Whether it is a personal loan, home loan, or business loan, every lender uses a structured method to calculate your EMI, total interest, and repayment schedule.
In India, loan calculation mainly depends on three factors: loan amount, interest rate, and tenure. Once you understand how these three work together, you can confidently compare offers and avoid paying extra interest.
At Saarathi.ai, we have observed that first-time borrowers often focus only on EMI. But smart borrowing means understanding the complete calculation, including reducing balance interest and amortization schedules. This guide explains everything in simple language so you can make informed decisions in 2026.
What Does Loan Calculation Actually Mean?
When a lender approves your loan, they calculate:
Your Monthly EMI
Total interest payable
Overall repayment amount
Detailed amortization schedule
Loan calculation is not random. It follows a standard mathematical formula used by banks and NBFCs across India, guided by regulatory norms from the Reserve Bank of India.
Let us break this down step by step.
The 3 Key Factors That Decide Your EMI
1. Loan Amount (Principal)
This is the amount you borrow.
Example: ₹5,00,000 personal loan.
Higher principal = Higher EMI and higher total interest.
2. Interest Rate
This is the cost of borrowing. In India, personal loan interest rates typically range between 10% to 24% depending on your credit profile, lender type, and income stability.
Interest can be:
Fixed rate
Floating rate
We will explain this shortly.
3. Loan Tenure
This is the repayment period. It can range from:
1 to 5 years for personal loans
Up to 30 years for home loans
5 to 15 years for business loans
Longer tenure means lower EMI but higher total interest paid.
The EMI Formula Explained Simply
EMI stands for Equated Monthly Installment. It includes both principal and interest.
The standard EMI formula used by lenders is:
EMI = P × R × (1+R)^N / ((1+R)^N − 1)
Where:
P = Principal loan amount
R = Monthly interest rate
N = Number of monthly installments
Do not worry about the math. Let us simplify with an example.
Example Calculation
Loan Amount: ₹5,00,000
Interest Rate: 12% per annum
Tenure: 3 years
Monthly interest rate = 12% / 12 = 1%
Using the EMI formula, your EMI will be approximately ₹16,607.
Total repayment = ₹5,97,852
Total interest paid = ₹97,852
At Saarathi.ai, our AI-powered comparison tool automatically calculates EMIs across 110+ lenders so you do not have to manually compute this. You can instantly compare personal loan offers on Saarathi.ai and see transparent repayment breakdowns.
Reducing Balance vs Flat Interest Rate
This is where many first-time borrowers get confused.
Reducing Balance Method
Interest is calculated on the outstanding principal, not the original amount.
As you repay EMI every month, the principal reduces. So the next month’s interest is calculated on a smaller amount.
This is the most common method used by banks and major NBFCs in India.
Flat Interest Rate
Interest is calculated on the full loan amount for the entire tenure.
Even if you repay part of the principal, interest remains calculated on the original amount.
Flat rates look lower but actually cost more.
At Saarathi.ai, we always recommend checking whether the rate is flat or reducing before applying. You can ask eligibility and interest questions directly via Saarathi AI expert chatbot for instant clarity.
What Is an Amortization Schedule?
An amortization schedule is a detailed table showing:
EMI amount
Interest portion
Principal portion
Remaining loan balance
For example, in the first EMI of ₹16,607 (from our earlier example):
Interest may be ₹5,000
Principal repayment may be ₹11,607
By the last EMI, interest becomes very small, and most of the EMI goes toward principal repayment.
When you apply through Saarathi.ai, you can track this full breakdown transparently inside the Saarathi Bazaar dashboard, which gives real-time visibility into loan offers and repayment structures.
How Credit Score Impacts Loan Calculation
Your EMI formula remains the same. But your interest rate changes based on credit score.
A higher credit score means:
Lower interest rate
Lower EMI
Faster approval
A difference of even 1% interest rate can significantly change total interest paid.
For example:
₹10 lakh loan for 5 years
At 11% interest → EMI approx ₹21,739
At 13% interest → EMI approx ₹22,753
Difference per month = ₹1,014
Difference over 5 years = ₹60,840
This is why improving your credit score before applying is powerful.
Recent reports from CRISIL indicate that borrowers with strong credit profiles receive significantly better lending terms, especially in digital lending platforms.
Fixed vs Floating Interest Rates
Fixed Rate
EMI remains constant
No impact from repo rate changes
Predictable planning
Floating Rate
Linked to repo rate
EMI may increase or decrease
Common in home loans
If the RBI changes repo rate, floating loan EMIs may change. According to coverage in The Economic Times, repo rate movements directly impact borrowing costs across India.
For first-time borrowers, fixed rate is easier to manage.
Processing Fees and Hidden Costs
Loan calculation is not just EMI. You must consider:
Processing fee
Prepayment charges
Late payment penalties
Foreclosure fees
For example:
Processing fee = 2% of ₹5 lakh = ₹10,000
Your effective loan received becomes ₹4,90,000 but EMI is calculated on ₹5 lakh.
At Saarathi.ai, we emphasize full transparency. All lender charges are visible before you apply.
How Prepayment Affects Loan Calculation
If you prepay ₹1 lakh after 1 year:
Your outstanding principal reduces
Total interest reduces
Tenure may shorten
Prepayment works best during early tenure because interest component is highest in initial months.
Many lenders allow partial prepayment after 6 or 12 months. Always check terms before signing.
Loan Calculation for Different Loan Types
Personal Loan
Short tenure
Higher interest
Fast approval
EMI sensitive to interest rate
Home Loan
Long tenure
Lower interest
Floating rate common
Larger impact of repo rate
Business Loan
May include structured repayment
Cash flow based
Sometimes moratorium period
Using AI recommendations via Saarathi Recommendation Engine, borrowers get tailored options based on income, risk profile, and repayment ability.
How Lenders Assess Your Repayment Capacity
Apart from EMI formula, lenders evaluate:
Monthly income
Existing EMIs
FOIR ratio
Employment stability
FOIR means Fixed Obligation to Income Ratio.
If your monthly income is ₹60,000 and existing EMI is ₹15,000, lenders check whether new EMI fits within acceptable limit, usually 40% to 50% of income.
This ensures you are not overburdened.
Smart Tips to Reduce Your EMI
1. Choose Longer Tenure Carefully
Lower EMI but higher interest overall.
2. Improve Credit Score Before Applying
Even 50 point improvement helps.
3. Compare Multiple Lenders
Never accept first offer.
4. Make Part Prepayments
Reduces interest burden significantly.
5. Negotiate Processing Fees
Many lenders reduce it for strong profiles.
Instead of manually checking different websites, you can instantly track your application in Saarathi Bazaar and compare offers from 110+ lenders in one place.
Common Mistakes First-Time Borrowers Make
Looking only at EMI, not total interest
Ignoring prepayment terms
Not checking flat vs reducing interest
Applying at multiple banks randomly, hurting credit score
Not reading loan agreement properly
At Saarathi.ai, we have observed that borrowers who use AI eligibility checks before applying have higher approval rates and lower rejection impact on credit score.
Frequently Asked Questions
1. How is EMI calculated in India?
EMI is calculated using the principal amount, monthly interest rate, and tenure using a reducing balance formula.
2. Does longer tenure reduce EMI?
Yes, EMI reduces but total interest paid increases significantly.
3. What is better, fixed or floating interest rate?
Fixed rate offers stability. Floating rate may reduce if repo rate falls but can increase during rate hikes.
4. Can I reduce my EMI after loan disbursal?
Yes, through prepayment, balance transfer, or tenure extension.
5. Does credit score affect EMI?
Yes. Higher credit score usually results in lower interest rate and lower EMI.
6. Is loan calculation different for NBFCs and banks?
The EMI formula is the same, but interest rates and charges may differ.
Conclusion
Understanding how loans are calculated helps you borrow smarter and save thousands in interest. Remember these key takeaways:
EMI depends on loan amount, interest rate, and tenure
Reducing balance method is more transparent than flat rate
Credit score directly impacts your borrowing cost
Prepayment can significantly reduce total interest
Always compare offers before final decision
Instead of guessing your EMI, discover personalized loan options, compare lenders, and get AI-driven recommendations. Discover the best loan offers on Saarathi.ai today and take control of your financial journey.
