Flat Vs Reducing Interest Rate: Which is Better?

A flat rate of interest differs from a reduced rate, so before you choose a loan, knowing which is better for you is important. Lenders offer various types of interest rates and a suitable option can lower your borrowing costs.

Read on to understand flat vs reducing interest rates.

What is a Flat Interest Rate?

A flat interest rate is the rate of interest that remains unchanged through the tenure of the loan. The interest is calculated for the total loan amount at the start of the loan tenure. The financial institution determines the EMI amount and the schedule of repayment.

In this type of interest rate, the liability remains fixed, helping you manage your finances better. However, keep in mind that the total interest liability is higher for flat rates when compared to reducing rates.

Check out the flat interest rate formula:

Flat interest rate = (P × R × T)/100

Where,

• P is the principal loan amount
• R is the interest rate in percentage
• T is the repayment period

What is Reducing Interest Rate?

A reducing rate is a type of interest in which your interest liability reduces with every EMI payment. This is because the interest is computed on the outstanding loan amount each time you repay a portion of the loan.

Since your interest dues decrease with every instalment, this can be a more cost-effective option.

Here is the formula for reducing interest rates:

Reducing interest rate = [P x R x (1+I) ^ T] ÷ [((1+I) ^ T) -1)]

Where,

• P = principal loan amount
• R = rate of interest / (100 x 12)
• T is the repayment period in years x 12

Also Read: Why Personal Loan Interest Rate is High?

Difference Between Flat and Reducing Interest Rates

Check out how flat and reducing interest rates differ, which can help you plan your loan terms better.

Type of Calculation

With a loan that has a reducing interest rate, the interest you pay is based on the outstanding loan amount. Here, the payable interest is calculated on the new principal after each EMI is paid.

On the other hand, the lenders calculate the flat interest rate on the original loan amount at the beginning of the loan tenure. After that, the total interest is added to the principal amount and divided by tenure. 

Ease of Calculation

Lenders calculate flat ROI vs reducing ROI very differently. It is comparatively easier to calculate the payable interest for flat interest rates. This is because they remain fixed throughout the duration of the loan.

The calculation of interest payable for reducing interest rates is complicated since the interest amount changes with each EMI you pay. In this case, the payable interest is calculated on the outstanding loan amount.

Suitability and Affordability

Reducing interest rate loans are comparatively more affordable, as with each EMI your interest liability for the loan reduces. However, this is not so in the case of flat-interest rate loans.

Benefits of Flat Vs. Reducing Interest Rates Calculator

To make the calculation of your loan interest easier, you can use a flat vs. reducing interest rates calculator. Here are some benefits of this tool:

• You can use the tool online anytime and anywhere with a device and internet connection
• You can get the results easily by inputting the basic details of the loan
• You can save time and energy by eliminating the need for manual calculations
• You can evaluate the total cost of your loan easily and plan the repayment better
• You can compare flat and reducing rates to understand which option is more cost-effective for you

The more time you save by calculating the EMIs digitally, the more time you can spend to compare rates in the financial marketplace and choose the best offer. Now that you know about flat vs reducing interest rates, make a smart borrowing decision. A flat rate of interest is easier to understand but can be expensive in the long run. So, research your options and choose one that suits your repayment plan while keeping the borrowing cost lower.

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FAQs on Reducing vs Flat Interest Rates

What is an example of a flat and reducing rate of interest?

Say you get a loan of ₹1 lakh for 12 months at a 10% interest rate. In a reducing balance interest rate calculation, your EMI will be ₹8,792 and the total payable amount comes to ₹1,05,499.

When you choose a flat interest rate, your EMI comes to ₹9,167 and the total payable amount will be ₹1,10,000. So, you stand to save ₹4,501 with a reduced interest rate calculation.

Which is better: a flat or a reduced interest rate?

A reduced interest rate can be better than a flat rate since it frees up your income as the tenure of the loan progresses. However, flat interest rates are more commonly available and easier to calculate.

Are reducing interest rates good?

With this method, you pay the loan principal amount sooner. This way, the interest on the outstanding amount decreases periodically. Thus, it may be a more affordable option. 

What financial products use flat interest rates?

Typically, personal loans and hire purchase agreements come with flat interest rates.