Flat vs. Reducing Interest Rate: Which is Better?

If you are looking for a loan, then it is vital to know about the types of interest rates. Banks and NBFCs offer different loans, and each one has its own way of calculating the EMI. For example, if you take a loan from a bank at a 10% flat rate for five years with an initial amount of Rs 1 lakh, your monthly EMI will be Rs 3,041.

However, instead of taking out a fixed-rate loan, consider the reduced-interest rate option instead. This can help reduce costs over a longer period by lowering the interest cost. Under the lower rate, your interest cost also reduces as you repay the loan. This makes it easier for you to finish the loan without stressing your finances. Keep reading to learn more. This will enhance your skill set.

The Flat Interest Rate and its Various Disciplines

Flat interest rates are easier to understand

Flat interest rates are more transparent and easy to understand. A flat interest rate is the sum of all payments over a period. This makes it easier to understand than lowering interest rates. But it is misleading in the long term. This is due to various issues associated with it. These issues can only be understood if you understand this concept.

Reducing your debt may seem like an attractive option at first glance, as you will save money on interest payments. After you figure out how much money each payment would cost you in total if you were paying off your debts with a reduction in their principal. Then you will learn that there aren’t as many savings involved as you may think!

The idea behind the concept of flat interest rates

As the name suggests, a flat interest rate is calculated as a uniform percentage of the loan amount. On the other hand, a reducing interest rate is based on the remaining principal each month.

The flat interest rate is permanent over the loan tenure. Hence, it is better for people who want a stable interest option for their loans.

You can plan for repayment

In contrast to decreasing interest rates, flat interest rates are stable in nature. Hence, one can plan ahead about the repayments and invest the money in other ventures as well. This is something that is not possible with reduced interest rates.

Formula to calculate

Interest per month = principal amount × tenure of the loan×interest rate per annum / total no of months you have to pay

A flat interest rate will have a higher EMI

With a flat interest rate, you will have a higher EMI than if you reduced your balance. So if you can afford to pay more for your loan, then only go for a flat interest rate. However, if you have to buy a new car or want to invest in a property.

Advantages of reducing rate over flat interest rate

Reducing interest rates are more affordable

If the interest cost on a loan is decreasing after each payment, the principal will be paid sooner. By paying off your debt sooner, you can save money in the long run. This is the case with reducing rates. Herein, the interest is calculated on the remaining principal every month. As you pay the EMIs, the interest cost will also be lower. Hence, you will be able to pay off the loan sooner. There will be less stress on your finances as well. Being an affordable option on the list makes it a much more attractive option.

Reducing interest rate is a little hard to understand

Reducing the rate is not easier to understand. You need to know about the concept of reducing interest rates before you can opt for it. Once you learn the key aspects of reducing interest rates, you will be well-equipped to use it as an option. Flat rates are easy to learn about and thus can cater to a much larger group of people.

Formula to calculate

The interest = total loaned amount × interest (changing) per month

Both of them are equally important

One thing that someone needs to understand is that both flat interest rates and reducing interest rates are equally important. They were not introduced to cater to the needs of a particular genre. The main reason behind the introduction is to give people options depending on what type of loan and term they choose. Some people don’t like the idea of reducing rates as it is harder to understand, and if you are not well aware of the financial process, there is a huge chance you will run into issues after some time.

Although this problem can be avoided with flat interest rates, it doesn’t provide the benefits of reducing rates. So the only way to swim through them is to understand them carefully before you dive into any of them. You can take the help of online articles, and there are many financial advisors who will thoroughly explain them and help you make a sound decision.

Conclusion

We discussed how flat interest rates and decreasing interest rates are both important, as well as the benefits of each. It is crucial for any person to understand the terms of the loans they are agreeing to and will have to pay for a long time, and you must learn more about interest rate options before you opt for one. Any mistake here can increase the cost of the loan for you. This can make it harder for you to pay back the loan on time. If you would like to learn more about how to manage your finances and make the most of your money, visit Piramal Finance. There are many articles and blogs here that will help you learn various financial concepts easily.