Equated Monthly Instalments (EMI) play a crucial role in loan repayment. The reducing balance method is a preferred choice for calculating EMIs, as it reduces interest costs over time. This method applies interest only on the outstanding principal, ensuring that borrowers pay less interest with each payment.
This article will explain how EMI is calculated in the reducing balance method. It will cover the concept, formula, step-by-step calculation using Excel, an example, and a comparison with the fixed interest method.
What is the monthly balance reducing method?
When you borrow money from a lender, you repay it through Equated Monthly Instalments (EMIs). Each EMI has two parts. One part reduces the original loan amount (principal), and the other part pays the interest charged by the lender. The way this interest is calculated can differ.
In the flat-rate method, interest is calculated on the full principal amount for the entire loan period. This means the interest portion in every EMI remains almost the same, regardless of how much you have already repaid.
Under the monthly balance reducing method, interest is charged only on the outstanding principal after each EMI is paid. As the loan amount reduces every month, the interest component also reduces gradually. Home loans usually follow this method, while some vehicle loans may use the flat-rate system.
What is the reducing balance method and how does it work?
The reducing balance method is a way to calculate interest where the interest amount decreases over time. Instead of charging interest on the entire loan amount, it is applied only to the outstanding principal after each EMI payment.
For instance, in a home loan, if Rs. 10,00,000 is borrowed at a 10% annual interest rate for 5 years, the interest for the first month is charged on Rs. 10,00,000. In the second month, after repaying part of the principal, interest is charged on the remaining balance. This continues until the loan is fully repaid.
This method benefits borrowers as they pay lower total interest over time compared to a flat-rate method.
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Key takeaways
- The reducing balance method allows depreciation to be charged more heavily in the early years of an asset’s life, helping reflect how quickly certain items lose value.
- This approach suits items such as electronic devices or technology-based equipment, which tend to become outdated faster and lose their usefulness sooner.
- Unlike the straight-line method, which spreads depreciation evenly, the reducing balance technique gradually lowers the expense each year as the asset’s remaining value decreases.
- A commonly used version, known as the double-declining method, speeds up depreciation even more by applying twice the standard reducing balance rate.
- Using accelerated depreciation methods can help businesses lower their taxable income in the initial years of owning an asset, offering financial advantages early on.
What is the formula for EMI calculation in the reducing balance method?
The formula to calculate EMI using the reducing balance method is:
EMI = (P x R x (1+R)^N) / ((1+R)^N - 1)
Where:
- P = Loan principal (amount borrowed)
- R = Monthly interest rate (Annual interest rate / 12)
- N = Loan tenure (in months)
Example calculation
| Parameter | Value |
| Principal (P) | Rs. 10,00,000 |
| Annual interest rate | 10% |
| Monthly interest rate | 0.0083 (10%/12) |
| Loan tenure (N) | 60 months |
Using this formula, the EMI for the above example can be calculated
While manual calculations help you understand the EMI structure, getting pre-approved for your home loan can simplify your property purchase journey. Bajaj Finserv offers home loans up to Rs. 15 Crore** with approval in just 48 hours*. Check your loan offers from Bajaj Finserv to know your eligible loan amount and EMI. You may already be eligible, find out by entering your mobile number and OTP.
How to calculate EMI in the reducing balance method using Excel?
Calculating EMI in Excel is a simple and efficient process. Follow these steps:
1. Open Excel and enter the following values in separate cells:
- A1: Loan Principal (Rs. 10,00,000)
- A2: Annual Interest Rate (10%)
- A3: Loan Tenure in Months (60)
2. Calculate the Monthly Interest Rate:
- In cell A4, enter =A2/12/100 to get the monthly rate.
3. Use the PMT function to calculate EMI:
- In cell A5, enter =PMT(A4,A3,-A1).
4. Press enter and the EMI amount will be displayed.
Using Excel allows users to adjust loan parameters and see real-time changes in EMI calculations.
How to calculate EMI using the reducing balance method?
To manually calculate EMI using the reducing balance method, follow these steps:
- Identify loan details: Gather loan amount, interest rate, and tenure.
- Calculate monthly interest rate: Convert annual interest into a monthly rate by dividing it by 12.
- Apply the EMI formula: Use EMI = (P x R x (1+R)^N) / ((1+R)^N - 1).
- Understand payment structure: Each EMI contains a portion for principal repayment and interest.
Example calculation
For a home loan EMI calculator, consider:
- Loan Amount = Rs. 5,00,000
- Interest Rate = 10%
- Tenure = 5 years
The monthly interest rate would be 0.0083, and using the formula, EMI can be calculated.
How to maximise loan savings with the monthly reducing balance method?
Once you understand how the reducing balance method works, you can take simple steps to reduce the total interest you pay over time. Since interest is calculated on the remaining principal, lowering that balance early can lead to meaningful savings.
Here are some practical ways to maximise your savings:
- Make part-prepayments whenever possible: If you receive a bonus or have extra savings, consider paying a lump sum towards your loan. Even a small additional payment reduces the outstanding principal, which in turn lowers the interest calculated in future EMIs.
- Opt for a shorter repayment tenure: Choosing a shorter loan term increases your EMI slightly, but it helps you repay the principal faster. As a result, the total interest paid over the loan period reduces significantly.
- Maintain a strong credit score: A good credit history improves your chances of securing a loan at a lower interest rate. Even a small reduction in the rate can result in noticeable savings when interest is calculated on a reducing balance.
- Consider a balance transfer: If another lender offers a lower interest rate, transferring the remaining balance of your loan may help reduce your overall interest outgo.
Reducing balance method vs fixed interest: Which one is better?
| Feature | Reducing balance method | Fixed interest method |
| Interest calculation | On outstanding loan balance | On the full loan amount |
| Total interest paid | Lower | Higher |
| EMI amount | Decreases over time | Fixed throughout the tenure |
| Best for | Long-term loans (home loans) | Short-term, small loans |
The reducing balance method results in lower interest costs over time, making it suitable for home loans.
If you are considering a home loan, choosing the right lender with favourable terms can maximise your savings through the reducing balance method. Bajaj Finserv provides home loans with no foreclosure charges for individual borrowers on floating rate loans, allowing you flexibility in loan repayment. Check your eligibility to benefit from these advantages. You may already be eligible, find out by entering your mobile number and OTP.
What are the advantages of EMI calculation using the reducing balance method?
The reducing balance method offers several advantages:
- Lower total interest costs: Interest is charged only on the remaining balance, leading to savings.
- Encourages early repayment: Paying extra towards principal reduces interest further.
- More financial flexibility: EMIs gradually decrease, easing financial pressure.
- Ideal for long-term loans: Especially beneficial for home loans due to high loan amounts.
The reducing balance method is a cost-effective way to calculate EMI, making it the preferred choice for borrowers. Since interest applies only on the outstanding balance, total interest paid is significantly lower.
For home loans, this method ensures affordability, especially when combined with significant loan amounts of up to Rs. 15 Crore* and competitive home loan interest rates starting from 7.15%* p.a.. Bajaj Housing Finance offers attractive options with flexible repayment plans extending up to 32 years, helping you manage your finances efficiently. Moreover, you can opt for a top-up loan to cover additional expenses.
Use a home loan EMI calculator to estimate repayments and choose the best loan plan. Apply for Bajaj Housing Finance Home Loan today and benefit from reduced interest costs, manageable EMIs, and speedy disbursal. To start, check your loan offers today. You may already be eligible, find out by entering your mobile number and OTP.
How does the monthly reducing balance method affect your loan?
The monthly reducing balance method influences several important aspects of your loan. From your EMI structure to the total interest paid, this method can make a noticeable difference.
EMI breakdown
With this method, the structure of your EMI changes over time. In the initial months, a larger portion of the EMI goes towards interest, and a smaller portion reduces the principal. As the outstanding loan amount decreases, the interest component reduces, and more of your EMI goes towards repaying the principal.
Interest burden
When comparing loan options, many borrowers focus on the total interest payable. Under the reducing balance method, interest is calculated only on the remaining principal. This generally leads to lower total interest compared to a flat-rate method, even if the quoted rate appears similar.
Faster principal repayment
Because the principal reduces with every EMI and the interest is recalculated each month, you gradually repay a higher share of the principal. This helps you clear your loan more efficiently and reduces your long-term financial burden.
Helpful resources and tips for home loan borrowers
Monthly reducing interest rate: When to choose
Choosing a monthly reducing interest rate can be a smart decision, especially if you want to control your total borrowing cost over time.
With this method, interest is applied only to the remaining loan amount. As you continue paying EMIs, the principal reduces, and so does the interest charged. This makes repayments feel lighter as the loan progresses.
It is particularly beneficial for long-term loans and higher loan amounts, such as Rs. 20 lakh or more, where even a small difference in interest calculation can lead to large savings. For shorter tenures or smaller loans, the difference may be limited but still beneficial.
Conclusion
Understanding how EMIs are calculated under the monthly reducing balance method helps you make informed borrowing decisions. Since interest is charged only on the outstanding principal, you end up paying less overall interest and reduce your loan amount steadily over time.
Many lenders apply this method to home loans. If you are planning to borrow for a house, consider trusted financial institutions such as Bajaj Finserv. We offer home loans with flexible tenures and competitive interest rates, helping you manage repayments smoothly while working towards your dream home without unnecessary financial stress. You might already be eligible; check your offers by entering your mobile number and OTP.
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