Interest is a part of the loan amount that is paid to the lender in addition to the principal amount. Loan interest rates are calculated in a similar manner by various banks. The interest rate is often shown as a percentage of the loan that is computed yearly and is also known as the Annual Percentage Rate (APR). Each EMI payment includes a component that goes toward the principle and a portion that goes toward the personal loan interest. Most loan interest rate agreements have greater interest parts, in the beginning, EMIs that decrease as the EMIs continue.
The EMI calculated against the principal amount, on the other hand, is smaller at the start of EMI repayment and rises as the term advances. There are several methods for calculating interest rates, and depending on the technique, you may obtain the lowest interest rate for a personal loan.
The first approach is dependent on whether the interest is computed on the original principal or the balance outstanding principal. The distinction between a reducing balance rate of interest and a flat rate of interest is explained below.
A Flat Interest Rate means a lending rate that stays unchanged through the loan tenure. The interest here is calculated for the whole loan amount at the beginning of the loan tenure. The financial organization decides on the repayment schedule and decides the EMIs payable by the borrower. It also keeps the total repayment liability fixed for a borrower and helps plan finance beforehand. Flat interest rates effectively remain higher than reducing rates.
In this scenario, the personal loan interest rate is determined based on the amount of principal owed at the end of a certain period. As previously stated, a portion of each EMI paid is applied to the principle, while the remainder is applied to interest. When computing interest, the next computation is based on the outstanding principal balance rather than the starting principal amount.
Below are some of their major differences:
Interest is computed on the initial principal amount throughout the loan duration in Flat Interest Rate loans.
Annual Interest Rate (I) – in percentage
Tenure (T) – in years
Total Interest = (P * I * T)/100
Total amount to be repaid = P + (P * I * T) /100
Monthly EMI = ( P + (P *I* T)/100) / T*12 (T is in years)
Interest is calculated on the remaining principal amount at any moment in Reducing Balance Interest Rate loans.
Calculation Formula: EMI = [P x Ix (1+I) ^T]/ [((1+I) ^T)-1)]
Total interest = monthly EMI x T – P
Total amount = monthly EMI x T
The Flat vs Reducing Rate Calculator is a calculator that allows you to compare both the methods of interest calculations and decide which is the best choice for you. It also allows you to see the difference in interest paid on your EMIs.
Through the calculator, you can effortlessly input the relevant details of your loan and get started. Here below are the steps to how you can use the Groww calculator:
Step 1: Enter the principal amount you availed as a loan on the calculator.
Step 2: Fill in the information of tenure and interest rate that was agreed upon.
Step 3: After this, you can just click on ‘calculate’ and find out how much interest you would pay on the loan you had availed.
Q1. What is the advantage of a flat rate?
The monthly payment at a flat rate does not change with time, and it helps you to manage your plan on a monthly basis.
Q2. What is the principal?
The principal is the original loan amount that you have or would like to avail of.
Q3. At a flat rate, how is the interest calculated?
In the flat rate method, the interest rate is calculated on the principal of the loan.
Q4. Which method is easier to calculate?
Calculating a flat interest rate is much easier than calculating a reducing rate.
Q5. How can I know my EMI before taking the loan?
You can do this through manual calculation. For the betterment of calculation, you can also refer to an EMI calculator available online.