What is a Flat vs Reducing Rate Calculator?
A Flat vs Reducing Rate Calculator is a financial tool or online calculator that helps borrowers compare the costs and EMIs associated with flat interest rates and reducing balance interest rates. This calculator assists individuals in understanding the potential savings or differences between the two interest rate calculation methods.
Before delving into the details of the Flat vs Reducing Rate Calculator, let’s understand the difference between both methods of interest calculation.
Flat Interest Rate
A flat interest rate is a type of lending rate that remains constant throughout the entire loan tenure. It means that the interest is calculated on the entire loan amount at the beginning of the loan period. With a flat interest rate, the total repayment liability for the borrower is fixed, allowing for better financial planning in advance.
Reducing Interest Rate
In the case of a reduced interest rate, the personal loan interest rate is determined based on the outstanding principal amount at the end of a specific period.
Difference Between Flat vs Reducing Interest Rate
The main difference between a flat interest rate and a reducing interest rate lies in how the interest is calculated and the impact it has on the total cost of the loan. Here are the key distinctions:
1. Calculation method:
- The flat interest rate is calculated based on the original principal amount throughout the loan tenure. The interest remains constant, regardless of any repayments made or the reduction in the outstanding balance. Each EMI payment includes the same interest amount.
- The reducing interest rate method calculates the interest based on the outstanding balance of the loan. As borrowers make periodic payments, the outstanding principal decreases, resulting in lower interest amounts over time. With each EMI payment, the interest portion decreases, and more of the payment goes towards reducing the principal.
2. Total interest paid:
- Flat Interest Rate: Since the interest amount remains constant throughout the loan tenure, borrowers end up paying a higher total interest amount. This is because the interest is calculated on the original principal, regardless of the reduction in the outstanding balance.
- Reducing Interest Rate: With the reducing interest rate method, borrowers pay less total interest over the loan tenure. As the outstanding principal decreases, the interest portion decreases as well, resulting in a lower overall cost of borrowing.
3. EMI amounts:
- Flat Interest Rate: The EMI amount remains the same throughout the loan duration since the interest component remains constant. However, the proportion of the EMI that goes towards the principal increases over time as the outstanding balance decreases.
- Reducing Interest Rate: With this method, the EMI amount typically decreases over time. As the interest portion decreases with each payment, more of the EMI is allocated towards reducing the principal.
4. Difficulty in the calculation:
- Flat interest rates are relatively easier to calculate manually since the interest amount remains constant.
- Calculating reducing interest rates manually can be more complex due to the changing outstanding balance. However, online calculators are available on Angel One to simplify the calculation process.
Flat vs Reducing Rate Calculator Formula
The formula for calculating the EMI (equated monthly instalment) for a loan with a flat interest rate is:
Total Interest = (P * R * T)/100
Total amount to be repaid = P + (P * R * T) /100
Monthly EMI = ( P + (P *R* T)/100) / T*12 (T is in years)
Where:
- P = Principal amount of the loan
- R = Annual interest rate
- T = Number of years to repay the loan
The formula for calculating the EMI for a loan with a reducing balance interest rate is:
EMI = [P x Ix (1+I) ^T]/ [((1+I) ^T)-1)]
Total interest = monthly EMI x T – P
Total amount = monthly EMI x T
Where:
- P = Principal amount of the loan
- R = Monthly interest rate/(100x12)
- T = Number of years x 12
How Does an Online Flat vs Reducing Rate Calculator Help You?
- Make a more informed decision: By knowing how much interest you will pay and how much the loan will cost you overall, you can make a more informed decision about whether or not taking out a loan is the right decision for you.
- Save money on interest: If you choose a reducing-rate loan, you will pay less interest over the life of the loan than if you choose a flat-rate loan.
- Make better financial decisions: By knowing how much interest you will pay on a loan, you can make a more informed decision about whether or not to take out the loan.
- Budget for your monthly payments: By knowing how much your monthly payments will be, you can make sure that you can afford to repay the loan.
