The interest rate is a vital aspect that you need to duly assess before taking any type of loan. For most borrowers, it qualifies as one of the primary factors that influences the final decision to choose a lender and apply for a loan. The interest rates also partially define the equated monthly instalments (EMI), which becomes a mandatory obligation for your enterprise.
Therefore, it is crucial for business owners to have a clear understanding of what interest rates are applicable, how they are calculated and the associated differences, before proceeding with the application process. In this article, we talk about flat and reducing interest rates, their primary differences, and which one would be best suited for your enterprise.
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What is a Flat Rate of Interest?
A flat or fixed rate of interest is calculated on the entire loan amount and does not change throughout the loan tenure. The amount is calculated at the beginning of the loan tenure and does not consider the reduction of the principal amount through timely EMI payments.
What is a Reducing Rate of Interest?
A reducing rate of interest is also known as a diminishing interest rate. It is calculated on a monthly basis, considering only the outstanding loan amount at that point. This means that once you successfully pay your EMI for a certain month, the reducing interest rate for the next month is calculated on only the outstanding figure after subtracting that installment, rather than the entire principal amount.
Ways to Calculate Flat and Reducing Rate of Interest EMI
As a business owner, you can make the right call by figuring out the instalments yourself. Here is how you can calculate the amounts:
- Fixed rate of interest: Interest on every instalment = (Total loan amount*loan tenure* yearly interest rate) / total instalments
Let’s say you took a loan of Rs 2,00,000 with a fixed interest rate of 10% per annum for a tenure of 4 years. You will end up paying 80,000 of interest (20,000*4*10/100)This would add up to a total of 280,000.
- Reducing interest rate: Interest on every instalment = outstanding loan amount* interest rate applied on every instalment
Suppose you have taken a loan of Rs 1 lakh at a variable interest rate of 10% per annum for a tenure of 5 years. The reducing interest rate would reduce your yearly payment amounts as you keep paying the installments. For instance, in the first year, the loan would incur an interest of around Rs 10,000, which would reduce to Rs 8,000 in the second year, and so on.
The Differences Between Flat and Reducing Rate of Interest
There are a variety of factors that differentiate the two interest rate structures. Let’s look at a few in detail:
- Rate of interest: The primary differentiator is the method by which the rate of interest is calculated. In a fixed interest rate, the amount is calculated on the total amount, whereas the reducing rate is calculated on a monthly basis on the outstanding amount.
- Ease of calculation: It is technically easier to calculate a fixed interest loan’s EMIs than those of a reducing loan. But you can easily use an online EMI calculator to figure out the latter.
- Tenure: A loan acquired at a reducing interest rate can have a longer tenure when compared to a fixed interest loan. This allows for more flexibility in terms of repayment.
- EMI amount: While the monthly EMI amount of a fixed interest loan remains unchanged over the loan tenure, in the case of a reducing rate loan, it progressively reduces over the period, as the interest amount comes down with each installment paid.
A host of financial bodies today present business owners with an extensive amount of variety when it comes to interest rates and loan structures. We at Kinara Capital offer collateral-free business loans at a reducing rate of interest. Our offerings include loans for working capital, asset purchase, and special loans specifically designed for women entrepreneurs (Her Vikas). Get in touch with us today to get your business on a growth path with a quick, easy and flexible loan.
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