EMI Calculation Using the Reducing Balance Method – Step-by-Step Guide

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 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.

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.

Read also: Understand how the monthly reducing balance method works for home loan interest

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.

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.

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 interest rates starting from 8.25%* p.a. Bajaj Housing Finance offers attractive home loan 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.