Loan applications made our life easier. Now we can fulfill our dreams without thinking over the price. But as the coin has two sides, loans also have hidden conditions and details which can make you fall prey to the Bank.
Bank provides various types of loans for different customer needs including home loan, car loan, personal loan, education loan and loan against property or gold.
It is true that loans made our life easier but lack of detail knowledge can make you fall into trap too. Let our experts tell you some major part of a loan process.
When you take a loan from bank for a time period, you are asked to return the principal amount with the interest applied on it within that decided time period. It is important to know that how bank calculates that interest amount on your loan.
There are only 2 major ways to calculate the interest on your loan amount:
- Flat interest rate
- Reducing balance rate
Flat Interest Rate Method
It is a rate of interest which is calculated over the full loan amount throughout its entire duration. It doesn’t consider EMIs which reduces the principal amount gradually. Due to this final rate of interest becomes larger than the Flat Rate mentioned at starting.
Calculation Formula for fixed interest rate:
Interest Installment paid = (Loan Amount × Years × Interest Rate p.a.) / No. of Installments
By the above formula you will be able to find out the interest amount on personal and car loans.
Reducing Interest Rate Method
It is a rate of interest which is calculated on monthly basis on the outstanding loan amount. In this, EMI is counted in the interest amount to be paid along with the principal amount. Each EMI reduces the outstanding loan amount gradually.
Calculation Formula for reducing balance rate:
Interest Installment paid on each = Interest Rate per Installment × outstanding Loan Amount
By the above formula you will be able to find out the interest amount for housing, mortgage, property loans, overdraft facilities, and credit cards.
How these methods differ from each other?
|Flat Interest Rate||Reducing Balance Rate|
|1. Rate of interest is calculated on the principal loan amount.||1. Rate of interest is calculated on the outstanding loan amount monthly.|
|2. Flat interest rates are lower||2. Reducing balance rates are higher|
|3. Flat interest rate calculation is easier||3. Reducing balance rate calculation is tough|
|4. Flat interest rate method is less preferable||4. reducing rate method is better|
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