Banks and non-banking financial institutions (NBFCs) offer a range of loans to satisfy the applicants’ financial requirements. Such financial support could come in the form of a personal loan, company loan, mortgage, or auto loan.
A personal loan is a loan that is provided with little to no documentation and without the need for security or collateral. The personal loan documents required when applying for a loan are
- Identification documents include a passport, driver’s licence, voter ID, and PAN card (anyone)
- Evidence of residence
- Passport / Utility Bill (not older than three months) / Leave and License Agreement (anyone).
- Recent three-month bank statement showing income or salary credits.
- Payslips – last three months
- 2 Passport Size photographs.
When it comes to personal loan interest rates, lenders often give borrowers the option of a flat rate or a falling balance rate. We’ll talk about how banks and other financial institutions decide on a loan’s interest rate in this post.
Understanding this math beforehand will help you make a decision that is in your best interests.
In essence, if you take out a loan for a specific amount of time, you must repay both the principal and any interest that accrued during that time. In this situation, it’s critical to comprehend the mathematics used to determine your personal loan interest rate.
There are two widely used methods for computing personal loan interest rates – the flat interest rate method and the reducing balance rate method. Both of these techniques result in varying amounts of interest that the borrower must pay. Consequently, it is helpful to comprehend how the two approaches work.
Table of Contents
What is a Flat Interest Rate?
The interest rate is calculated using the whole principal sum in the flat interest rate technique. In this case, the interest rate and payment amount stay the same for the duration of the loan. It fails to take into account the fact that the principal is steadily reduced by the monthly EMIs.
The effective interest rate is considerably higher than the initial estimate for the nominal flat rate. The fixed rate of interest is calculated using the formula below:
Interest payable/instalment = (interest rate p.a.*number of years*principal loan amount)/number of instalments
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Benefits of Flat Interest Rate
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Easy calculation
The flat rate approach simplifies calculations. Transparent loan arrangements are made possible by the flat interest rate. They are easily accessible to and manageable by both the lender and the borrower.
An EMI calculator makes the computation even easier. A small amount of data must be entered for the calculator to swiftly and accurately produce results.
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Effective planning
Because the EMI doesn’t change from month to month, you can conveniently manage your monthly finances. You can save yourself the trouble of tedious planning and monthly EMI calculations by doing this. An EMI calculator makes the computation even easier.
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Lower interest rates
Generally speaking, stable personal loan interest rates are more affordable than declining balance rates.
What is Reducing Balance Interest Rate?
A monthly interest rate that is depending on the size of the existing loan balance is referred to as “reducing” or “diminishing.” The principal repayment and the payable interest on the remaining loan balance are both included in the EMI for this option. An EMI calculator makes the computation even easier.
Each EMI payment reduces the remaining balance of the loan. The interest for the following month is computed only based on the amount of the outstanding loan. The lowering balance rate is calculated using the formula below:
Interest payable/instalment = Remaining loan amount * Interest rate per instalment
The reducing balance interest technique is frequently used to calculate the interest due on credit cards, personal loans, property loans, overdraft facilities, property mortgage loans, and housing. The only part of the borrower’s outstanding loan that is subject to interest is the remaining balance.
Benefits of Reducing Balance Interest Rate
When compared to other personal loan interest rates such as flat interest rates, the main benefit of a reducing balance interest rate is that the borrower eventually has to pay less interest.
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Conclusion
In conclusion, the simplicity of flat rates and reduced interest rates may not be as advantageous as first thought. Although flat rates are simple to comprehend, they can be misleading when it comes to repaying big loans. You can save yourself the trouble of tedious planning and monthly EMI calculations by doing this.
Before submitting a loan application, use online calculators to compare the personal loan interest rates for both types of interest options.
When considering a loan, apart from knowing the personal loan documents required, it’s critical to understand whether the lender uses the reducing balance technique or the flat interest rate method to determine interest.
The best way to compare the actual cost of a loan is to convert everything into the equivalent of the Effective Interest Rate.
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