How to Calculate and Compare Flat and Reducing Interest Loans

 

Understanding the differences between flat and reducing interest rate loans is crucial for making informed borrowing decisions. While both loan types have their advantages, calculating and comparing them can help you determine the best option for your financial needs. This article explains how to calculate and compare flat vs reducing interest rate loans, ensuring you make the right choice.

How To Calculate Flat and Reducing Interest Loans

Flat Interest Loan Calculation

In a flat interest loan, the interest is calculated on the entire principal amount throughout the loan tenure. To calculate the total interest, multiply the principal loan amount by the interest rate and the loan tenure. Then, divide the result by the loan tenure to get the monthly interest payment.


Example of Flat Interest Calculation

For a loan of ₹1,00,000 at a 10% annual interest rate for 5 years, the total interest would be ₹1,00,000 × 10% × 5 = ₹50,000. The EMI is then calculated by adding the principal amount to the total interest and dividing by the loan tenure (60 months for 5 years).


Reducing Balance Loan Calculation

In a reducing balance loan, the interest is calculated on the outstanding principal amount, which decreases as you repay the loan. For each instalment, the principal is reduced, and interest is calculated only on the remaining balance.


Example of Reducing Interest Calculation

If you borrow ₹1,00,000 at a 10% annual interest rate for 5 years, interest for the first month is calculated on the entire principal. However, after each EMI payment, the principal decreases, lowering the interest on subsequent payments.


Comparison of Total Payments

A flat interest loan results in higher total interest payments because the interest is calculated on the full principal amount for the entire tenure. In contrast, a reducing balance loan generally costs less over time as interest is calculated on the remaining principal.


Conclusion

Understanding how to calculate and compare flat and reducing-interest loans is essential for making informed financial decisions. A flat-interest loan may seem simpler but often results in higher total interest payments due to the interest being calculated on the full principal amount throughout the loan tenure. On the other hand, reducing interest loans offer lower overall interest costs as they calculate interest only on the outstanding balance. When considering a personal loan, it’s crucial to assess both the loan type and the total cost, including interest. By calculating both options, you can choose the loan that best suits your financial goals, ensuring more manageable repayments and long-term savings.
 


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