When taking out a loan, one of the key factors affecting monthly payments is the Equated Monthly Instalment (EMI). Surprisingly, even with a higher interest rate, borrowers may end up with a lower EMI depending on the method used for calculating interest.
To demonstrate this, let's compare two different loan scenarios with the same principal amount and tenure, but using two different interest calculation methods: the flat rate method and the reducing balance method.
In the flat rate method, the interest is calculated on the full loan amount for the entire loan tenure, irrespective of the amount of the principal that has been repaid. As a result, the EMI amount remains the same throughout the term of the loan.
Ram borrows ₹10,00,000 at a flat interest rate of 11.4% for 10 years. The monthly EMI for this loan is ₹17,833.
In this case, despite paying a fixed ₹17,833 EMI, Ram’s total interest cost is ₹11,40,000 over the life of the loan, which brings the total amount repayable to ₹21,40,000.
In the reducing rate method, the interest is calculated only on the outstanding balance of the principal. As the borrower makes payments, the principal reduces, and so does the interest. This leads to a decrease in the EMI over time, even though the initial interest rate may be higher.
Shyam borrows ₹10,00,000 at a reducing interest rate of 12.65% for 10 years. Despite the higher rate, his monthly EMI is ₹14,725.
Although Shyam's interest rate is higher, the total interest paid is significantly lower than Ram's because the interest is calculated on the reducing balance. The result is a lower total repayment of ₹17,67,042, and a lower EMI of ₹14,725. You can check the same using Flat vs Reducing Rate Calculator.
This situation may appear counterintuitive at first. After all, Shyam is paying a higher interest rate (12.65%) compared to Ram’s 11.4%. However, the key reason for the lower EMI in the reducing rate method is that interest is calculated only on the remaining principal amount.
As Shyam repays his loan, the outstanding principal reduces, which in turn reduces the amount of interest charged on it. This results in a lower EMI, even with a higher nominal interest rate.
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The EMI amount can differ significantly depending on the loan's interest calculation method. While the flat rate method leads to a higher EMI due to interest being calculated on the full principal amount, the reducing rate method offers a lower EMI, as the interest is calculated only on the outstanding loan balance.
Understanding these differences can help borrowers make more informed decisions about their loans and manage their finances better.
Disclaimer: This blog has been written exclusively for educational purposes. The securities or companies mentioned are only examples and not recommendations. This does not constitute a personal recommendation or investment advice. It does not aim to influence any individual or entity to make investment decisions. Recipients should conduct their own research and assessments to form an independent opinion about investment decisions.
Investments in securities are subject to market risks. Read all related documents carefully before investing.
Published on: Sep 3, 2025, 3:04 PM IST
Team Angel One
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