Fixed vs. Reducing Balance EMI

When borrowing money in Canada or the US, the method used to calculate your Equated Monthly Installment (EMI) can significantly affect your repayment strategy. Fixed EMI and reducing balance EMI are two common approaches, each with distinct impacts on interest paid and payment structure.

This guide explores the differences between fixed and reducing balance EMI methods, helping borrowers in Toronto, Vancouver, New York, and beyond choose the best repayment strategy. Use our free EMI calculator to test these methods for your loans.

In a fixed EMI loan, the interest is calculated on the initial principal amount throughout the loan term, similar to a simple interest loan. The total interest is determined at the start using the formula: Interest = P × R × T, where:

• P is the principal loan amount.
• R is the annual interest rate (as a decimal).
• T is the time in years.

The total repayment (principal + interest) is then divided into equal monthly payments, ensuring consistency but often resulting in higher interest costs since the interest doesn’t decrease as the principal is repaid.

In a reducing balance EMI loan, interest is calculated on the outstanding principal each month, using the formula: EMI = P × r × (1 + r)^n / [(1 + r)^n - 1], where:

• P is the principal loan amount.
• r is the monthly interest rate (annual rate ÷ 12 ÷ 100).
• n is the number of monthly payments.

Each EMI payment reduces the outstanding principal, lowering the interest charged in subsequent months, which typically reduces the total interest paid over the loan term compared to a fixed EMI.

Here’s how fixed and reducing balance EMI methods differ for borrowers in Canada and the US:

• Interest Calculation: Fixed EMI calculates interest on the initial principal throughout the term; reducing balance EMI calculates interest on the remaining principal each month.
• Total Interest Paid: Fixed EMI often leads to higher total interest; reducing balance EMI typically results in lower interest since the principal decreases monthly.
• Payment Predictability: Both methods offer fixed monthly payments, but fixed EMI may feel less cost-effective over time.
• Early Repayment Benefits: Reducing balance EMI benefits more from early repayments, as interest is recalculated on the lower principal; fixed EMI offers less savings since interest is predetermined.

The chart below compares the interest paid over time for a $20,000 loan at 5% annual interest over 3 years (36 months) using fixed and reducing balance EMI methods.

Here’s a comparison of fixed and reducing balance EMI for a $20,000 loan at 5% annual interest over 3 years in Canada and the US:

These examples illustrate that reducing balance EMI often results in lower total interest, making it a cost-effective choice for many borrowers in Canada and the US.

Ready to explore EMI options for your loan? Use our free EMI calculator to test scenarios for your loan in Canada or the US.