We’re discussing how banks and other financial organisations compute a loan’s interest rate. In a murky scenario like this, when no bank person would give you the exact interest rates and other details, it’s even more critical to know how to calculate this in advance. In basic terms, when you take out a loan for a specific length of time, you must repay the main amount as well as the interest within that time frame. Aside from the loan rate, it’s critical to understand how the bank will compute interest on your house loan. The flat interest rate technique and the falling balance interest rate approach are the two most prevalent ways for calculating interest on loans.

What is Flat Interest Rate?

A flat interest rate refers to a rate of interest that is determined on the full loan amount. If you apply for a business loan in India, the interest rate will remain the same throughout the duration of the loan. Flat interest rates are usually more expensive than interest rates that are being reduced.

In this case the personal loan interest rate is calculated on the initial principal amount without accounting for the principal repaid. This method of interest calculation results in a higher EMI. This can be understood better with the example below,

Let us assume you take a Rs. 1, 00,000 loans at 10% interest rate. The interest component for every year would be 10,000/-. So in case you would like to repay the loan in 3 years, the total of the principal amount and the interest rate would be Rs 1,00,000/- + Rs, 30,000/- i.e. Rs 1,30,000/- This will be divide by 3 years i.e. a total Rs 1,30,000/- divided by 36 months i.e. Rs. 3612 per year. The same in case of a reducing balance approach would be would be Rs. 3227/-. This best personal loan interest rate you can look for in the case of some private lenders for a quick loan.

Benefits of Flat Interest Rate Loans

The calculation for a flat rate is very straightforward. Both the lender and the borrower may readily follow loan agreements made at a fixed interest rate since they are transparent. In India, all semi-financial entities provide flat MSME and corporate loan interest rates, such as village banks, self-help groups, and ASCA.

Many borrowers in developing countries, including farmers, seek loans with balloon payments. The reason for this is that a flat rate calculation is simpler to comprehend.

Prior to the invention of currency, the concept of a flat rate of interest existed. It’s the most common method of repaying a loan in regular instalments.

What is Reducing Interest Rate?

A reducing rate for a personal loan calculates interest on the principal amount outstanding at the conclusion of a given term, as opposed to fixed vs. lowering rates. As you pay your EMIs, a portion of your principle is lowered, and the remainder is used to pay interest. The interest rate for the next month will change since it will be based on the new principle owed.

For example, if you obtain a loan of Rs 1,00,000 for 5 years at a lowering rate of interest of 10% p.a., your EMI cost would decrease with each payments. You would pay Rs 10,000 in interest the first year, Rs 8,000 on a decreased principle of Rs 80,000 the second year, and so on, until you only paid Rs 2,000 in interest the last year. You would pay Rs. 1.3 lakh instead of Rs. 1.5 lakh, as opposed to Rs. 1.5 lakh if you used the fixed rate option.

Benefits of Reducing Balance Loan Interest Rate

The primary benefit associated with a reducing balance interest rate is that as time passes, the applicant has to pay lesser interest compared to flat interest rate loans.

However, in the case of a flat rate, the loan will be repaid in a shorter duration, so the interest for the months that have been paid in advance need not be paid. However, in reducing interest rate, the duration of repayment and the interest component will also be impacted.

Differences between Flat Interest Rate and Reducing Interest Rate

Checkout our Flat Vs Reducing Balance Rate calculator to have a clear idea about it.

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