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Flat Interest Rate Vs. Reducing Balance Interest Rate
Posted on Friday, February 28th, 2025 | By IndusInd Bank
When applying for a personal loan, one of the key factors to consider is the type of interest rate applied to your loan. Two common methods banks use for calculating interest are the flat interest rate and the reducing balance interest rate.
The experience you have with your loan can depend largely on the type of interest rate applied to the loan. Hence, understanding flat vs. reducing interest rates is crucial to choosing a loan that best suits your financial needs.
What is a Flat Interest Rate?
- A flat interest rate is a method where the bank calculates the interest on the entire loan amount throughout the loan tenure.
- The interest component within the EMI (Equated Monthly Instalment) will remain the same through the tenure.
- For instance, let’s assume you take an instant personal loan of ₹1 lakh with a flat interest rate of 10% over five years. Here, the 10% interest is calculated on the ₹1 lakh principal amount for the entire five years.
- Traditionally, banks have used flat interest rate to calculate interest for loans and other credit offerings.
What is a Reducing Balance Interest Rate?
- In the reducing balance interest method, the bank calculates interest on the outstanding loan balance.
- As you repay the loan each month, the principal reduces. The interest for the next period is calculated on this remaining balance. This means that with each EMI payment, you pay less interest and more towards the principal.
- In the reducing interest rate method, EMIs may be more interest-heavy at the start. However, they gradually focus on repaying the principal.
- As a result of this approach, the interest payments gradually decrease. Thus, a reducing interest rate can lower the overall loan cost.
Note that even though the interest and principal components change with time within the EMI, the EMI amount remains fixed in reducing interest rate as well.
The type of interest rate applied on a loan varies amongst banks. If you are unaware of the interest rates but still want to get an estimate of your EMIs, consider using a personal loan EMI calculator. This tool will give an approximate EMI based on your loan amount and tenure. So, you can choose the right loan and repay it with ease.
Difference Between Flat Interest Rates and Reducing Balance Interest Rates
A flat vs. reducing interest rate comparison is crucial for borrowers as it impacts how much they will pay over the life of a loan. Let’s compare both on the following aspects:
| Aspect | Flat Interest Rate | Reducing Balance Interest Rate |
| Interest Calculation | Calculated on the full loan amount throughout the tenure. | Calculated on the loan balance remaining after each EMI. |
| EMI | EMI remains the same throughout the loan tenure. | The interest component of the EMI starts higher but reduces over time, while the principal component increases with time. However, the EMI amount remains fixed. |
| Total Interest Payable | Higher interest paid over the loan period. | Lower total interest due to declining interest on the outstanding balance. |
| Loan Tenure Impact | Loan tenure does not majorly affect the interest calculation. | Tenure has an impact on the overall loan cost. |
| Suitable For | People who prefer lock to the interest component of their loan. | People looking to minimise total interest paid over time. |
Which is Better for You – Flat Interest Rate or Reducing Balance Interest Rate?
Let’s consider some factors to help you decide between the two:
Long-Term Savings
A reducing interest rate is ideal if you are looking to minimise the total interest you will pay over the loan tenure. This is especially beneficial for personal loans with higher amounts.
Loan Amount and Tenure
For smaller, short-term loans, the difference between a flat interest rate and a reducing interest rate may not be significant. However, for larger, longer-term loans, a reducing balance method can lead to substantial savings.
Also Read: Understanding Personal Loan Interest Rates
Conclusion
When deciding between a flat interest rate and a reducing interest rate, it is important to assess several factors. For larger loans or longer tenures, the reducing balance method tends to be more cost-effective. However, if interest-consistency is your priority, a flat interest loan might be a better option.
If a Personal Loan with an attractive interest rate is what you are looking for, IndusInd Bank is the banking partner you need.
IndusInd Bank offers Personal Loan options with attractive interest rates, flexible repayment options, instant approval and disbursal, and more. We offer a transparent interest rate structure to help borrowers have a smooth and trustworthy experience. Apply now!
Disclaimer: The information provided in this article is generic and for informational purposes only. It is not a substitute for specific advice in your circumstances. Hence, you are advised to consult your financial advisor before making any financial decision. IndusInd Bank Limited (IBL) does not influence the views of the author in any way. IBL and the author shall not be responsible for any direct/indirect loss or liability incurred by the reader for making any financial decisions based on the contents and information.
