Difference in Flat and Reducing Interest Rates: Which one is better for you?
- Posted on October 27, 2020
By Karan KapoorThe banks and finance companies provide various forms of loans to meet the financial needs of consumers. Some banks and financial institutions lend home loans, loans for cars, personal loans, college loans, and loans against properties and gold. The method of applying for a loan is slightly different from knowing the various facets of the loan. The bank staff or agents who deal with you will highlight the image's shiny face. They'll never tell you in advance about the comprehensive circumstances and other important things. So, you need to get the knowledge right before you fall into some hole.
Interest is a percentage of the value of the debt above and beyond the principal's value to the lender. The interest rate on personal loans functions equally with various banks and NBFCs too. Interest rate is typically represented as a percentage of the debt, also known as the average percentage rate (APR), and quarterly. That EMI payout includes a percentage that goes towards the principal balance and the remainder that goes towards personal loan interest. Any best personal loan interest rate offer in the initial EMIs will have higher interest portions, decreasing as the EMIs progress. On the other hand, at the outset of EMI servicing, the EMI measured against the principal balance becomes smaller and rises with the period increasing. There are different methods to measure interest rates, and depending on the process, you will get the lowest interest rate for a personal loan.
Reducing Interest Rates
Reducing / Every the balance rate, as the phrase implies, means an interest rate measured on the loan's remaining amount per month. Under this form, the EMI requires, in addition to the principal balance, interest due on the remaining loan amount for the month. The outstanding balance of the loan gets each after every EMI payment.
Interest Payable per Instalment = Interest Rate per Instalment * Remaining Loan Amount
If you take a Rs 1 00,000 loan with a lower interest rate of 10% p.a. For any redemption, the EMI balance will then be every 5 years. You would pay Rs 10 000 as interest in the first year; in the second year, you'd pay Rs 8,000 on a reduced Rs 80,000 principal, and so on, till the last year you'd pay Rs 2,000 as interest only. Similar to the fixed-rate form, you would end up charging Rs. 1.3 lakh rather than Rs. 1.5 lakh!
In specific, this approach is used to measure interest owed on rent, leases, land loans, overdraft services, and credit cards. In this way, you have to pay interest on the remaining balance of the loan. The interest rates quoted on these loans are the Effective Interest Rate, close to the Fixed Deposits (FD), and Savings Accounts interest rates used.
Flat Interest Rates
As the term suggests, a flat interest rate means an interest rate measured on the entire balance of the debt during its lifetime without recognising whether monthly EMIs slowly lower the principal amount. As a consequence, the Actual Interest Rate is considerably higher than the originally quoted nominal Flat Rate.
Interest Payable per Instalment = (Original Loan Amount * No. of Years * Interest Rate p.a.) / Number of Instalments.
When you take a Rs 1 00,000 loan with a 10% p.a. flat interest rate, you will bill for 5 years, then:
Rs 20,000 (main repayment @ 1,00,000/5) + Rs 10,000 (interest @ 10% of 1, 00,000) = Rs 30,000 annually or Rs 2,500 per month.
You will literally pay Rs 1, 50,000 (2,500 * 12 * 5) for the entire duration. So, in this case, Rs. 2,500 's monthly EMI translates to 17.27% effective interest rate p.a.
This form is used in particular for estimating the interest owed on personal loans and car loans. Throughout that way, you will pay interest on the full value of the debt over the loan's lifetime. It's probably less common with lenders because even though you're paying down the debt slowly, interest is not going down. Translated to the same Nominal Interest Rate, flat interest rates usually vary from 1.7 to 1.9 times higher.
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