What is an EMI?
EMI stands for equated monthly instalment: an equal monthly payment. A fixed monthly amount is worked out from the loan size, the interest rate and the term, so that paying it every month clears the whole loan with interest by the end. Home, car and personal loans, even a fridge or phone bought on a card, all work this way.
The instalment stays the same, but the split inside it changes. Early on, most of each payment goes on interest, because the balance is still large. Over time the balance falls, the interest part shrinks and the share repaying the principal grows.
Say Jamil takes a loan for a motorbike. The shop says “only Tk 5,000 a month”, and that is the only number he looks at. Later he works out that over 36 months he pays Tk 1,80,000 in total, while the bike’s cash price was Tk 1,40,000. The Tk 40,000 difference is the real cost of the loan. The story and numbers are made up.
Why it matters to an investor
- To measure the real cost: not the monthly instalment, but the total repaid minus the amount borrowed, is what the loan costs.
- To compare two offers properly: whether the same “12%” is a flat or a reducing-balance rate can nearly double the total cost.
- To see the term trap: a longer term lowers the instalment but raises the total interest.
- To see how much future income is tied up: every EMI locks away part of your monthly income for years, money that could have gone to saving or investing.
Flat rate versus reducing balance
With a reducing balance, each month’s interest is charged only on what is still owed. As you pay, the balance falls, and so does the interest. Bank loans usually work this way.
With a flat rate, interest for the whole term is charged on the full original amount, even though you are paying the principal back every month. So for the same headline number, a flat rate costs much more. Shop instalment plans and informal lending often work this way; it is worth getting in writing which method a rate uses.
Costs beyond interest
Besides interest, a loan’s total cost includes processing fees, documentation or stamp charges, sometimes compulsory insurance, and VAT on fees. Late instalments bring late fees, and paying the whole loan off early can bring an early-settlement fee.
In 2021 Bangladesh Bank capped some bank charges: on loans up to Tk 50 lakh, the processing fee is at most 0.5% (no more than Tk 15,000), and the early-settlement fee at most 0.5% of the outstanding amount. These caps can change, and lenders outside the banking system follow different rules.
When the interest rate changes
Many loans have variable rates: when market rates rise, so does the loan rate. Since the 9% cap was lifted in July 2023, lending rates in Bangladesh have been market-based, and they have risen since then. When the rate rises, either the EMI goes up or the term gets longer; either way the total cost grows.
- Before borrowing, find out: whether the rate is fixed or variable, how often it can change, and whether a change raises the EMI or the term.
Worked example
- Say you borrow Tk 2,00,000 over 24 months at 12% a year.
- Reducing balance: the monthly rate is 1%. The EMI is about Tk 9,415; over 24 months you pay about Tk 2,25,950 in total. Interest: about Tk 25,950.
- Flat rate: interest = 2,00,000 × 12% × 2 years = Tk 48,000. Total Tk 2,48,000, EMI about Tk 10,333.
- Expressed as a reducing-balance rate, the flat-rate instalment works out at about 21.6% a year. Add a Tk 1,000 processing fee and even the reducing-balance loan costs about 12.5%.
Result: both say “12%”, but the flat rate costs about Tk 22,000 more in interest. Compare the total repaid, not the headline rate. The numbers are only an example; you can use the time value of money calculator for your own sums.
See the numbers as a table
| Total interest | |
|---|---|
| Reducing balance | Tk 25,950 |
| Flat rate | Tk 48,000 |
Common mistakes
- Deciding on the monthly instalment alone, without looking at the total repaid.
- Treating a flat rate and a reducing-balance rate as the same thing.
- Stretching the term to lower the instalment, without checking how much more interest that adds.
- Signing without reading the processing fee, insurance, early-settlement fee and rate-change terms.
The true cost of a loan = everything you repay (all instalments and fees) − what you borrowed. Compare this number, not the instalment.