There are basically two prevalent rate structures employed by money lenders- Flat Rates and Reducing Balance Rates.
Flat Interest RatesUnder the Flat Interest Rate scheme, interest is calculated on the entire personal loan amount, against the tenure. The effective interest rate is higher than the nominal flat rate that is usually quoted at the beginning. For instance, if you take a personal loan worth Rs 4,00,000 for a tenure of 3 years against an interest rate of 12%, the interest payable under the flat rate structure would be Rs 1,44,000.
Key features of Flat Interest Rates:- The interest is calculated on the principal loan amount
- Flat interest rates are lower than that of the reducing balance rate
- Easier to calculate the interest rate calculation on flat interest rate than reducing interest rate
Reducing or Diminishing Interest RatesThe interest in reducing interest rate method is calculated on the outstanding loan amount every month. The EMI includes the interest payable on the outstanding loan amount. Meaning, as and when repayments are made, the interest is accordingly levied and computed on the remaining balance.
While lenders can use both type of rates to advertise their product, the interest rate on a loan under a reducing balance basis is usually higher than under the flat rate regime. Meaning, a Flat Interest Rate of 10% might amount to an interest of 15% or more under the reducing balance basis – this is dependent on the loan amount and the tenure in question.
But, in practical terms, the reducing or the diminishing interest rate method is better as you will not be spending more towards the interest.
Learn more about your Personal Loan Eligibility here
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
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