Difference Between Flat Rate Interest and Reducing Rate Interest

Reducing Rate Interest

In reducing rate interest, partial payments made over time result in lower interest. It is also known as a diminishing interest rate. The interest rate is calculated on the outstanding loan amount every month. When the principle amount decreases annually then it is known as annual rest.

Benefits of Reducing Rate Interest

When compared to loans with flat interest rates, the main advantage of a reduced interest rate is that the applicant will eventually have to pay less in interest. Yet, in the case of a flat rate the loan will be repaid in a shorter duration, so the interest for the months that have been paid in advance need not be paid. However, the duration of the repayment period and the interest component will also be impacted by a lower interest rate.

The Formula for Calculating Reducing Rate Interest

Interest payable per Instalment = (Original loan amount x Number of years x Interest rate p.a.) / Number of instalments

An example of Reduced-Rate of Interest:

An example of a three-year loan is shown below. However, your loan tenure may range up to 30 years. We usually pre-pay our loans when they have a 30 or 20-year term. The advantages of a reduced interest rate are greater compared to those of a flat interest rate.

• Original principal : 1,00,000
• Interest rate : 12.00% p.a.
• Loan tenure : 3 years
• Principal outstanding : 1,00,000
• Total interest paid : 19,571.52
• EMI : 3,321.431

Difference between Flat and Reducing Interest Rate

1. In the flat rate process, interest is calculated on the initial principal throughout the loan term, while in the reducing balance method, the interest is based on the remaining outstanding principal.
2. Flat interest rates usually are lower than reducing interest rates. Assume the lender will charge a 12% flat rate and an 18% reducing interest rate. However, you will end up paying more interest overall in the 12% flat rate than in the 18% reducing interest rate over the loan’s tenure.
3. It is easy to determine the flat rate using a flat-rate interest calculator compared to the reduced-rate interest.
4. The ability to pre-pay a portion of the loan to decrease the interest burden makes a reduced interest rate preferable to a flat rate from the borrower's viewpoint view.

Conclusion

In general, reduced interest rates and flat rate interest's ease of calculations might not be as beneficial as previously thought. Although flat rate interests are simple to understand, experts believe that they are misleading when it comes to repaying large loans. Therefore, check the interest rates on both options using internet calculators before requesting for a loan. Make an informed decision.