What is flat interest rate?
In flat interest rate method, interest is calculated on the original principal amount throughout the loan tenure. For example, on a ₹10 lakh loan at 10% for 5 years, interest is calculated on ₹10 lakh for all 60 months, regardless of repayments.
What is reducing balance interest rate?
In reducing balance method, interest is calculated on the outstanding loan balance. As you pay your EMIs, the principal reduces, and so does the interest component. This is the most common method used by banks today.
Which method is better for borrowers?
Reducing balance method is better for borrowers as it results in lower total interest payment. Flat rate method effectively doubles the interest cost compared to reducing balance method for the same nominal rate.
How much more expensive is flat rate?
Flat rate is approximately twice as expensive as reducing balance rate. For example, a 10% flat rate is equivalent to about 19% reducing balance rate in terms of actual cost.
Which lenders use which method?
Most banks and NBFCs use reducing balance method today. Flat rate is typically used by some private lenders, chit funds, and informal lending arrangements. Always check the method before signing loan documents.
How to identify the interest method?
Check your loan agreement for terms like "flat rate" or "reducing balance". You can also calculate a sample EMI - if it matches the reducing balance calculation, that's likely the method used.
Can I switch methods after taking loan?
Generally, you cannot switch from flat to reducing balance method after taking a loan. However, you can prepay the loan to reduce the outstanding amount and thereby reduce interest burden.
Why do some lenders still use flat rate?
Flat rate method is simpler to calculate and results in higher interest income for lenders. It's easier to explain to borrowers who may not understand the reducing balance concept.