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Flat Vs reducing balance Interest Rates

July 23rd, 2009 by
  • cut-interest-rate1

    Most people whom I have met are confused about flat rate and reducing balance interest rate. Flat rates are usually lower than reducing balance rates and the normal human tendency is to opt for a rate that is lower because this seems to suggest that the burden on a borrower will be less. But what’s the catch? It’s the details that one must have to be careful about. Let us first get our basic right.

    One must note that though a flat rate is lower, it always comes at a higher cost than an annual reducing balance rate. In the latter case, the effective total interest paid out also depends on the time periods – daily, monthly, quarterly, half-yearly and yearly – when the rate is calculated. In a flat rate loan, the rate is calculated on the principal amount of a loan, while in a reducing balance loan, interest rate is charged only on the outstanding amount of a loan on a periodic basis.

    Let me take an example of a friend who was offered a Rs 2 lakh loan at 10 per cent flat or 11 per cent reducing balance for a period of 3 years. If he had opted for the fixed or flat rate of interest then he would have had to pay an interest of Rs. 20,000 for each of the three years, amounting to a total of Rs. 60,000 in just interest. However, he went for the reducing balance rate in which he had to pay only Rs. 35,678 in total interest over 3 years at an EMI of Rs 6,548 ( check our EMI Calculator to see the details ), leading to a whopping savings of Rs 24,322 for him.

    So my advice would be that guys, do not make haste, first read the fine print, do your homework and make informed decision regarding any financial product.

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    3 Comments

3 Responses to “Flat Vs reducing balance Interest Rates”

  1. Manikandan said on

    thank you… this has really helped me….

  2. vexPlaizeJeli said on

    Very nice article.

  3. hi thanks for this information.
    but if there is wide difference for flat rate & reducing rates which one we must opt.

    i am living in UAE and bank is offering me a loan of 150000 with flat rate of 5.3% or reducing rate of 9.75%. which one i should go with.

    Expecting your soonest reply.

    Thanks in advance.
    Prasad

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