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The rate of interest calculated on the total loan amount for the entire tenure, and not considering a reduction in the principal amount or any market fluctuations, is known as the flat rate of interest. If you choose a flat rate of interest for your loan, the Effective Rate of Interest is considerably higher than a floating rate of interest. If a borrower wants to set a fixed budget schedule and plan out the repayment schedule accordingly, they will select a Flat rate of interest for the certainty that it offers.
Flat interest rate calculator
The following is the formula to calculate the flat rate of interest –Loan Amount x Number of years x Rate of Interest (p.a.) Interest Payable per Installment = Number of InstallmentsSuppose you take a loan for Rs. 10 lakhs for five years and a flat interest rate of 10% p.a. The total amount repaid is calculated as –
- Principal Repayment = Rs. 2 lakhs every yearInterest = Rs. 1 lakh every yearRepayment = Rs. 3 lakhs per annum, which means an EMI of Rs. 25000 p.m.
- Total Repayment over the tenure of five years = Rs. 15 lakhs.This means that the Effective Rate of Interest here comes to a whopping 17.27%
Benefits of Flat Interest Rate
- Suitable for planning an accurate budget as the EMI remains constant throughout.
- Flat interest rates are lower than reducing interest rates.
Drawbacks of Flat Interest Rate
- The Effective Rate of Interest paid by the borrower is considerably higher.
- The borrower cannot reap the benefit of a reduced rate even if he repays a considerable part of the principal.
Who prefers to pay a flat interest rate?
Flat interest is not popular among the borrowers as the interest rate gets calculated for the whole term on the entire loan amount, even if the borrower repays the loan and the principal amount goes down. When converted to Effective Rates of Interest, as seen above, flat interest rates are almost 1.5 to 2.5 times higher than a reducing rate of interest.However, which type of interest rate best suits you is your personal preference. A flat rate would be better for someone who needs a stable rate of interest with no fluctuations or changes. It is imperative to assess flat and reducing interest rates and read all the fine print carefully before you opt for any one of them.
FAQS - FREQUENTLY ASKED QUESTIONS
What is flat interest rate vs reducing interest rate ?
There are basically two ways to calculate interest on a loan: flat interest rate or reducing balance interest rate also known as reducing interest rate. In a flat interest rate loan, the interest rate and the amount of interest remain the same throughout the loan tenure avoiding any kind of market fluctuations. While in reducing interest rate loans, the interest is calculated on the outstanding principal amount and not on the original loan amount. As a result, the amount of interest keeps on decreasing throughout the loan tenure. However, the rate of interest can change as per market conditions in this type of loan.
What is a flat interest rate and how is the interest calculated ?
A flat interest rate is a rate that stays the same throughout the tenure of the loan and hence gives the borrower a simple and easy way in planning his repayment schedule. The interest payable on every installment in Flat Interest Rate loan is calculated as:
Interest Payable on each Installment = [ Loan Amount x No. of years x Rate of Interest (p.a.) ] / No. of Installments in the loan
How is the effective rate of Interest in a Flat Interest Rate loan higher than the actual rate ?
To understand how the effective rate of interest on a flat interest rate loan is higher than the actual rate, let us take an example. Let’s say you have borrowed a loan of Rs. 1 Lakh and the interest rate on the flat interest rate loan is 10%. The repayment period is 5 years and hence the EMI would be,
EMI = Principal Repayment Amount + Interest Amount
Principal Amount to be paid back in [ 5 Years x 12 Months = 60 Months ] 60 Installments. Hence Rs. 1 Lakh paid in equal 60 installments comes to Rs. 1,666.67 per installment
Interest Amount to be paid = [ 1,00,000 x 5 x 10% ] / 60 = Rs. 833.33
Therefore, EMI = Rs. 2,500
Total amount repaid = Rs. 2,500 x 60 = Rs. 1,50,000
Effective Rate of Interest = 17.27% (Calculated using the Time Value of Money method)
Which type of interest rate is better for a home loan ?
Flat Interest Rate loans are simple and easy to understand and give the borrower comfort in planning the repayment of the loan in an easier way. Such loans are also not prone to market fluctuations and hence the rate of interest remains the same throughout the tenure of the loan. On the other hand, the reducing balance loan or reducing interest rate loan is complicated to understand and there remains a risk for interest rates to change as per market conditions. But the effective interest on a flat interest rate, however, is higher than the reducing balance loans and hence the borrower also ends up paying a higher interest amount during the tenure of the loan. Therefore, a reducing interest rate loan is better than a flat interest rate loan.
What are the pros of flat rate ?
It’s time saving since it helps one to straightforwardly estimate the EMI as the interest rate remains uniform every month and throughout, which in turn eliminates the hassle of calculation. Faster estimation of EMI in turn helps individuals to determine their upcoming obligations and take care of their money matters precisely beforehand.
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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