Skip to content

CS Professional · Banking and Insurance - Laws and Practice · Calculation of Interest and Annuities

Meera takes a home loan from a scheduled commercial bank, repayable in equal monthly instalments (EMIs) with interest charged on the monthly reducing balance. Which statement correctly describes how each EMI is made up over the loan tenor?

In an equal-EMI reducing balance loan, the interest component falls and the principal component rises with each instalment. Interest is calculated on a shrinking outstanding balance, and since the EMI stays fixed, the balance of each payment goes towards repaying more principal.

  1. AThe interest component rises and the principal component falls with each successive EMI
  2. BBoth the interest and principal components remain constant in every EMI
  3. CThe interest component falls and the principal component rises with each successive EMICorrect
  4. DThe principal is repaid only in the last EMI and earlier EMIs cover interest alone

Explanation

On a reducing balance loan, interest is charged on the outstanding principal. Each EMI repays some principal, so the next month's interest is lower. The EMI is fixed, so the principal part must rise as the interest part falls. The opposite pattern in the first option describes a loan where interest is on a growing balance, which does not happen here.

Did you get it right without looking?

One question tells you little. A timed set on Calculation of Interest and Annuities shows your real accuracy, how long you take and where you lose marks.

Practise Calculation of Interest and AnnuitiesFree diagnostic mock

More Calculation of Interest and Annuities questions