Reducing and Flat Rate of Interest: Know the Key Differences

A flat rate of interest differs from a reduced rate, so before you choose a loan, knowing which is better for you is important. Lenders offer various types of interest rates and a suitable option that can lower your borrowing costs.

Read on to understand flat vs reducing interest rates.

What is a Flat Interest Rate?

A flat interest rate is the rate of interest that remains unchanged through the tenure of the loan. It is calculated for the total loan amount at the start of the loan tenure. The financial institution determines the EMI amount and the schedule of repayment.

In this type of interest rate, the liability remains fixed, helping you manage your finances better. However, keep in mind that the total interest liability is higher for flat rates when compared to reducing rates.

Check out the formula for a flat rate of interest:

Flat interest rate = (P × R × T)/100

Where,

• P is the principal loan amount
• R is the interest rate in percentage
• T is the repayment period

What are Reducing Interest Rates?

A reducing rate is a type of interest in which your interest liability reduces with every EMI payment. This is because it’s computed on the outstanding loan amount each time you repay a portion of it.

Since your interest dues decrease with every instalment, this can be a more cost-effective option.

Here is the formula for reducing interest rates:

Reducing interest rate = [P x R x (1+I) ^ T] ÷ [((1+I) ^ T) -1)]

Where,

• P is the principal loan amount
• R is the rate of interest / (100 x 12)
• T is the repayment period in years x 12

Also Read: Why Personal Loan Interest Rate is High?

Difference Between Flat and Reducing Interest Rates

Check out the difference between flat and reducing interest rates, which can help you plan your loan terms better.

• Type of Calculation

With a loan that comes with a reducing rate of interest, you need to pay interest based on the outstanding loan amount. Here, the payable interest is calculated on the new principal after the payment of each EMI.

However, the lenders calculate the flat interest rate on the original loan amount at the beginning of the loan tenure. After that, the total interest is added to the principal amount and divided by tenure. 

• Ease of Calculation

Lenders calculate flat ROI vs reducing ROI very differently. It is comparatively easier to calculate the payable interest for flat interest rates. This is because they remain fixed throughout the loan.

Calculating the interest payable for reducing interest rates is complicated since the interest amount changes with each EMI you pay. In this case, the payable interest is calculated on the outstanding loan amount.

• Suitability and Affordability

Reducing interest rate loans are comparatively more affordable, as with each EMI your interest liability for the loan reduces. However, this is not so in the case of flat-interest rate loans.

Now that you know how to think about a flat rate vs reducing rate, make a smart borrowing decision. A flat interest rate is easier to understand but it can be expensive in the long run. So, research your options and choose one that suits your repayment plan while keeping the borrowing cost lower.

To meet your needs easily and quickly, you can get the Fibe Instant Cash Loan. You can benefit from competitive interest rates, minimal documentation requirements and quick approvals. Download the Fibe Personal Loan App or register on the website to get a loan of up to ₹5 lakhs hassle-free.

FAQs on Reducing vs Flat Interest Rates

What is an example of a flat and reducing rate of interest?

Say you get a loan of ₹1 lakh for 12 months at a 10% interest rate. In a reducing balance interest rate calculation, your EMI will be ₹1,195 and the total payable interest comes to ₹72,091.

When you choose a flat interest rate, your EMI comes to ₹1,528 and the total payable interest will be ₹1,20,000. So, you stand to save ₹47,909 with a reduced interest rate calculation.

Which is better: a flat or a reducing interest rate?

A reducing interest rate can be better than a flat rate since it frees up your income as the tenure of the loan progresses. However, flat interest rates are more commonly available and easier to calculate.

Is reducing interest rates good?

With this method, you pay the loan principal amount sooner. This way, the interest on the outstanding amount decreases periodically. Thus, it is a more affordable option.