Money is an indispensable part of one’s life. A monetary need may arise at any time and arranging the required lump sum may not always be easy. In that case, there is nothing wrong with taking a loan. A personal loan, as the name implies, is an unsecured loan to satisfy your personal financial needs. The personal loan interest calculation is an important task while applying for such a loan.

When you decide on a personal loan, there are two important things to consider. First, you need to match the personal loan eligibility criteria. Look at the websites of different lenders—whether banks or non-banking financial companies like Bajaj Finserv. Once you are eligible to apply for the loan, get a hold of a personal loan calculator. There are two types of personal loan interest rates—flat rate and reducing rate. To know which one is a better fit for you, it is important to understand what they mean.

Flat rate

Flat personal loan interest rates apply to the personal loan principal at a flat rate for the whole tenor. Even after paying a few installment payments, when the principal amount gets reduced considerably, you continue paying the interest on the whole loan amount.

Here’s an example to get a better idea of what a flat rate is. Suppose you have taken out a loan of Rs.5 lakh at a flat interest rate of 10% with a five-year tenor. At this rate of interest, your yearly interest payout will be Rs.50,000. As your tenor is five years, you will be paying off Rs.1 lakh of principal each year. Thus, your principal will decrease to Rs.4 lakh after the end of the first year. But, as the interest rate is flat, you will still be paying Rs.50,000 as interest each consecutive year. That stands true for the fifth year, too, even though the remaining principal amount will become Rs.1 lakh.

Reducing the rate

In contrast, a reducing interest rate applies to the remaining principal amount. The reduced interest rate is always calculated on the outstanding loan amount. As the principal amount gets reduced year by year due to the EMI repayment, the total interest payment also keeps decreasing.

Looking at the following example should help you understand the reducing interest rate. This time, suppose you have availed yourself of an Rs.5 lakh personal loan at a 10% interest rate with a five-year tenor again. The only difference is that the interest rate is reducing this time. So, after the first year, you end up paying Rs.50,000 as interest and Rs.1 lakh as principal repayment. After that, your total outstanding loan amount will be Rs.4 lakh after two years. As your principal is reducing, the total interest will be calculated based on the reduced principal amount. Therefore, throughout the second year, you will be paying 10% interest on Rs.4 lakh, which is Rs.40,000. The interest repayment for all consecutive years will decrease similarly.

Flat rate vs. reducing the rate

Now that you have an understanding of the two interest rate types, it is easy for you to choose the right one for you. Here are a few takeaway points for your reference:

✔ For a flat interest rate, you always pay interest on your initial principal amount. So, your effective interest rate increases as the principal amount decrease.
✔ The reducing interest rate calculation seems more economical as you only pay interest on the outstanding loan amount.
✔ Calculating a flat personal loan interest rate is much easier than calculating a reducing interest rate.
✔ You end up paying more money as interest loan repayment if you choose a flat rate personal loan.

Conclusion

A personal loan is a convenient way to arrange funds for any personal needs. To grab your best offer for a personal loan, understanding the different types of interest rates may be helpful. Check with your lender to get a suitable offer. There may be different interest rates available for fixed and reducing categories. Still, compare them by calculating total interest to take the right decision.

While you are at it, check out the pre-approved deals available to you. For instance, Bajaj Finserv offers pre-approved personal loans to simplify the loan process and help you save on time. All you have to do is share a few basic details and check out your pre-approved offer.