Loans offered by lending institutions attract one of the two kinds of interest rates: reducing balance rate and flat rate interest rate. It is important to know what sets both of these two apart so that you can decide which one will work best for you. Read on to know more.

A flat interest rate system is calculated on the entire loan amount beforehand. It does not account that the principal sum is reduced over the course of the repayment tenure. Hence, the EMI obligation remains static throughout the tenure if other factors remain constant.

It is calculated with the help of the following formula:

(Principal Amount x Flat Interest Rate (percentage or decimal) x Length of the repayment tenure (In years)) / Repayment tenure (Expressed in Months)

 

To illustrate with an example, let us just assume that Mr. Singh has secured a personal loan of ₹2,00,000 at a flat interest rate of 10% that he is going to repay over 10 years.

 

Given the above figures, the interest component of your monthly personal loan EMI outflow will look as follows:

 

(₹2,00,000 x 10% x 5)/60 = ₹1,666.67

So, your total interest payable over the course of your repayment tenure (5 years) will be:

 

₹1,666.67 x 60 (months) = ₹1,00,000

 

Now, let us add the principal amount to the above figure, which is another ₹2,00,000. So, the total amount that will be paid to the borrower will amount to ₹3,00,000. This will be paid off in 60 EMIs, so the borrower’s monthly outflow will be approximately ₹5,000 a month.

• Easy to Manage: 

Since it is relatively simple to calculate and understand, it is easy for all parties involved to keep track.

• EMI Obligation Remains Static: 

Your monthly EMI obligation remains the same throughout the tenure, making it easier for you to plan your budget. 

The interest rate which is calculated on the outstanding principal loan amount is known as the reducing or diminishing balance interest rate system. The EMIs of loans with this kind of interest rate are made up of two parts: outstanding principal amount and the interest calculated on the principal. The interest component of every instalment is calculated simply by multiplying the remaining loan amount to the interest rate per instalment.

As you can imagine, borrowers that take up a loan with a reducing balance interest rate system pay a lesser amount as interest over time. This is because the interest component of every subsequent EMI is calculated on the outstanding loan amount.

Some differences between the two forms of interest rates are:

Although relatively complex to calculate, it is clear that a personal loan with a reducing balance interest rate system will be more pocket friendly for you. You can avail one from Bajaj Markets itself through any of our lending partners. As a Bajaj Markets user, you will be able to enjoy benefits such as flexible repayment tenures, competitive interest rates and loan top ups. Apply Now!