Flat Interest Vs Reducing Balance: Don't harm yourself in the pursuit of a cheap personal loan, understand this difference

If you do not know the difference between flat interest rates and reducing balance, then you can make a wrong deal with personal loans and can harm yourself in the pursuit of cheap personal loans.

A personal loan is also called an emergency loan. Although nowadays there are many ways to raise funds in an emergency, but still personal loans are very helpful on many occasions. A personal loan is an unsecured loan, to take which there is not much hassle. But in return for this loan, banks charge a good amount of interest from the customer. Most people know that personal loans is expensive.

Interest is charged on this loan in two ways, Flat Interest Rate and Reducing Balance Interest Rate. This is where the whole game of expensive and cheap happens. If you do not know the difference between a flat interest rate and reducing balance, then you can make a wrong deal of personal loan and in the pursuit of cheap personal loan, you can harm yourself.

What is reducing interest rate?

The name of reducing balance interest rate itself suggests that in this, the customer has to pay interest only on the outstanding loan amount. This means that the interest to be paid every month is calculated on the basis of the remaining loan, not on the actual loan. For example, if you have taken a loan of Rs 5 lakh at a rate of 16 percent for five years, then as the months pass, the EMI will also start decreasing.

What is flat interest rate?

In flat rate, the customer has to pay interest on the entire loan amount during the loan period. Suppose you have taken a loan of Rs 5 lakh at a flat rate of 10 percent for five years, then your EMI of Rs 4,167 per month is fixed, you will have to pay this EMI for the entire 5 years. Taking a loan on reducing interest rate is cheaper than flat interest rate.

This is how you suffer loss due to one decision

Many times non-banking finance companies (NBFCs) offer flat interest rate with low interest rate on personal loans. Whereas the interest rate of personal loan in banks can be a little higher, but it is mostly on reducing interest rate. If the customer does not know the difference, then he gets trapped in the trap of cheap loan and takes loan on flat interest rate and causes loss to himself.

Understand with an example

Suppose a bank offers you a personal loan of Rs 5 lakh at 15 percent interest. This is reducing balance interest and you take it for 5 years. At the same time, an NBFC offers a personal loan of Rs 5 lakh to someone known to you with 12 percent interest, but that is flat interest rate. The repayment period for this is also 5 years only.

In such a situation, if we calculate according to the Flat vs Reducing Rate Calculator, then in reducing balance interest rates, a customer will have to pay Rs 7,13,698 in 5 years to repay a loan of Rs 5 lakh. In this, he will pay Rs 2,13,698 as interest. On the other hand, if a customer takes a loan for five years at a flat interest rate of 12 percent, then he will have to pay Rs 8,00,000 for it. That is, despite the cheap interest rate, he will pay Rs 3 lakh only as interest.