Should You Take A Personal Loan On A Flat Interest Rate Or Reducing Balance Interest Rate? - Loan Trivia


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Saturday 16 January 2021

Should You Take A Personal Loan On A Flat Interest Rate Or Reducing Balance Interest Rate?


Flat interest rates and reducing balance interest rates are the two most prevalent structures based on whichpersonal loan interest rates are calculated. The rate levied on personal loans usually range between 10% and 25%. But the interest rate being charged from a borrower can vary according to his or her credit score, income, age, employment stability, repayment history, etc. The amount of loan availed and selected repayment tenure for also impacts personal loan interest rates.

While some lenders apply flat interest rates on a personal loan, some charge a reduced balance interest rate. These two rates differ on the lines of how it calculated, what factors affect it, and so on. The rate could be equal in both these approaches, but each will impact the loan repayment differently. As a borrower, you have the option to choose between these two.

Flat interest rates and reducing interest rates

Flat, or fixed rate of interest on a personal loan is a simple and straightforward way of calculating interest. As its name suggests, the interest rate in this approach remains constant throughout the loan tenure. It is charged on the gross principal sum borrowed by an individual and remains unchanged long as the loan is entirely repaid.

Contrarily, reducing balance rate has the interest amount changing as its tenure progresses. This is because a reducing rate is charged on the outstanding loan balance, and not on the gross sum borrowed. Thus, as the tenure progresses, the due balance to be repaid decreases. This, in turn, also brings down a borrower's interest outgo in the later stages of loan repayment.

You must thoroughly understand the working of flat interest rates vs reducing interest rates to get the best personal loan interest rate. Under a flat rate scheme, a borrower will have to pay the same EMIs throughout, irrespective of their principal balance. A reducing or diminishing balance rate scheme might charge higher EMIs initially. However, the amount comes down over time.

What should you choose?

The choice between flat interest rates and reducing balance interest rates can never be obvious. Neither should this decision be taken simply by judging the advertised rates. It is important to compare these charges and assess your profitability in the long-run.

Reducing balance interest rates shows the real cost of borrowing. Thus, it is advisable to convert all the rates into the effective rate of interest (EIR) or reducing balance interest rate to understand and compare the loan liabilities of each. It will show you the real interest rate and the actual gross amount you are repaying as a personal loan.

Some lenders might give you the option to choose between flat interest rates vs reducing interest rates while some might not. You must enquire about this from a lender in advance as well. You also need to understand the other personal loan charges which you will have to bear.

If you are availing an online personal loan, you will get to interact with the representatives on a lender’s portal itself. You can also go through the terms, conditions, interest rates, related charges, benefits, etc., of the credit online.

Well-known financial institutions like Bajaj Finserv now extend unique and special pre-approved offers to borrowers. These offers can be availed on secured as well as unsecured loans. It helps simplify the application process and reduce the time taken to disburse credit. Have a look at your pre-approved offers by sharing your name and phone number online.

Your decision to opt for a flat or reducing balance interest rate also determines the affordability of your loan. Make sure to account every term, condition, and other charges before making your choice.

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