Being financially aware and vigilant is important for everyone, especially millennials. Financial awareness is growing rapidly across generations. However, when we take a closer look at a particular segment – personal loans, a lot of questions hover around the concept especially when it comes to choosing the right lender, interest rates, repayment plans and so on.
Lenders have made it possible for us to avail flexible and pocket friendly loans at our beck and call. But when speaking of interest rates, even erudite professionals may stay boggled as to how interest rates are calculated and what interest rates would prove to be affordable for the longer run.
Let’s understand the types of interest rates, their calculations and the affordability to spare you the trouble.
Flat Interest rate
Flat Interest rates also known as Fixed Interest rates is a type of interest that is traditionally applied to personal term loans. Here, the interest rate is calculated on the entire loan amount i.e., the principal amount. The total interest is calculated in the beginning and the “Principal + Interest” is then divided into equal instalments to repay the loan.. These rates are usually lower in denomination typically between 8 to 12 %
Reducing Interest rate
In the case of a reducing interest rate, the interest amount is recalculated on the outstanding principal every month. Interest amount reduces every month along with your principal amount.
When you pay your monthly EMI, a part of this payment goes toward the interest payment for that month and the remaining goes toward the payment of the principal amount. So, in the subsequent month, the principal amount is reduced, and the interest amount is also lowered since it is calculated on that reduced principal amount. These interest rates are usually higher in denomination as compared to flat rate of interest; typically between 16 to 30%.
Understanding the affordability of Interest Rates
When looking for a personal loan, you must make a fair comparison to understand which type of interest is levied on the loan and what would it cost you in the long run. When you hear 10% interest rate (flat) vs 18% interest rate (fixed), your brain is bound to make that quick calculation that 10% would certainly prove to be more affordable as it is lower. However, that’s not quite the case. Both these interest rates would cost you almost the same.
Let’s understand these calculations with illustrations of both Flat and Reducing interest rates
Loan Amount : INR 1,00,000
Loan Tenure: 12 months
Interest rate: 10% Flat / Fixed Interest rate
| Installment | Interest | Installment | Principal paid |
| 1 | 833 | 9,167 | 8,333 |
| 2 | 833 | 9,167 | 8,333 |
| 3 | 833 | 9,167 | 8,333 |
| 4 | 833 | 9,167 | 8,333 |
| 5 | 833 | 9,167 | 8,333 |
| 6 | 833 | 9,167 | 8,333 |
| 7 | 833 | 9,167 | 8,333 |
| 8 | 833 | 9,167 | 8,333 |
| 9 | 833 | 9,167 | 8,333 |
| 10 | 833 | 9,167 | 8,333 |
| 11 | 833 | 9,167 | 8,333 |
| 12 | 833 | 9,167 | 8,333 |
| 10,000 | 110,000 |
Loan Amount : INR 1,00,000
Loan Tenure: 12 months
Interest rate: 18% Reducing interest rate
| Installment | Interest | Installment | Principal paid |
| 1 | 1,500 | 9,168 | 7,668 |
| 2 | 1,385 | 9,168 | 7,783 |
| 3 | 1,268 | 9,168 | 7,900 |
| 4 | 1,150 | 9,168 | 8,018 |
| 5 | 1,029 | 9,168 | 8,139 |
| 6 | 907 | 9,168 | 8,261 |
| 7 | 783 | 9,168 | 8,385 |
| 8 | 658 | 9,168 | 8,510 |
| 9 | 530 | 9,168 | 8,638 |
| 10 | 400 | 9,168 | 8,768 |
| 11 | 269 | 9,168 | 8,899 |
| 12 | 135 | 9,168 | 9,033 |
| 10,016 | 110,016 |
Unbelievable isn’t it?! It is instinctive of the human brain to believe that an interest rate with a lower denomination is bound to be more affordable. However, on the basis of the above illustrations, you can clearly see that there is barely any difference in how much it is going to cost you. The difference narrows down to a few bucks and often in favour of reducing interest rate!
Demanding a certain rate of interest is influenced by many factors like product type, loan amount, loan tenure, collateral, credit worthiness of the borrower and so on. Thus, as a borrower you must be well aware of which loan you are opting for and avoid being tricked by the face value of the interest rates. Use the Personal loan EMI calculator to be doubly sure of the calculations before being aggressively conclusive.
At LoanTap, we offer Personal loans ranging from INR 1,00,000 to INR 10,00,000, for tenures between 6 months to 5 years. We levy 18%-30% (Reducing) interest rates on our personal loans and offer flexible repayment options to ensure more affordability for our customers.
Related article – Guide to Different Types of Interest Rates – Flat vs Reducing Rate of Interest
