Interest is a part of the loan amount that is paid to the lender in addition to the principal amount. Loan interest rates are calculated in a similar manner by various banks. The interest rate is often shown as a percentage of the loan that is computed yearly and is also known as the Annual Percentage Rate (APR). Each EMI payment includes a component that goes toward the principle and a portion that goes toward the personal loan interest. Most loan interest rate agreements have greater interest parts, in the beginning, EMIs that decrease as the EMIs continue.

The EMI calculated against the principal amount, on the other hand, is smaller at the start of EMI repayment and rises as the term advances. There are several methods for calculating interest rates, and depending on the technique, you may obtain the lowest interest rate for a personal loan.

The first approach is dependent on whether the interest is computed on the original principal or the balance outstanding principal. The distinction between a reducing balance rate of interest and a flat rate of interest is explained below.

Flat Interest Rate

A Flat Interest Rate means a lending rate that stays unchanged through the loan tenure. The interest here is calculated for the whole loan amount at the beginning of the loan tenure. The financial organization decides on the repayment schedule and decides the EMIs payable by the borrower. It also keeps the total repayment liability fixed for a borrower and helps plan finance beforehand. Flat interest rates effectively remain higher than reducing rates.

Reducing Interest Rate

In this scenario, the personal loan interest rate is determined based on the amount of principal owed at the end of a certain period. As previously stated, a portion of each EMI paid is applied to the principle, while the remainder is applied to interest. When computing interest, the next computation is based on the outstanding principal balance rather than the starting principal amount.

Differences Between Flat Vs Reducing Interest Rate

Below are some of their major differences:

• Form of Calculation: In reducing rate, the interest rate is accrued under diminishing rate and is based on the outstanding loan amount. A flat interest rate is when the interest is calculated on the total principal amount sanctioned.
• Comparision Rate: Under flat rate,, interest is calculated in a method usually at a fixed percentage than reducing interest rate.
• Interest Rate Equivalence: Flat rate calculations result in a higher interest rate equivalence, and reducing rates reflect the effective interest rate initially
• Interest Rate Calculation: Calculating a flat interest rate is much simpler than reducing interest rates