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ESG
While borrowing a loan, a thorough understanding of interest rate charges is crucial to know the total payable amount. Flat interest rate is one such approach where interest is levied on the entire loan amount for the total loan term. Although this approach provides fixed EMIs, it tends to yield a greater total interest outgo than a reducing balance interest rate.
If you are thinking of a personal loan, understanding how these calculations are done can assist you in making a financially wise choice.
What is a flat interest rate and how does it work?
A flat interest rate applies a fixed percentage of interest on the total loan amount throughout the loan tenure, irrespective of how much has already been repaid.
Formula for flat interest calculation
Total interest = (Loan amount X Flat interest rate X Tenure in years)
EMI = (Loan amount + Total interest) / Loan tenure in months
Since interest is charged on the original principal and does not decrease with repayments, the overall interest paid is significantly higher than that of a reducing balance interest loan.
Flat interest rate vs reducing balance interest rate
Feature |
Flat interest rate |
Reducing balance interest rate |
Interest calculation |
On the full principal for the entire tenure |
On the remaining balance after every EMI payment |
Total interest paid |
Higher |
Lower |
EMI amount |
Fixed for the entire tenure |
Decreases over time |
Best suited for |
Short-term loans |
Long-term loans |
Example:
A ₹ 5 lakhs loan with a 10% flat interest rate for 5 years will have ₹ 2.5 lakhs as interest.
The same loan with a reducing balance will also have a much lower interest rate, as it is charged just on the falling principal after each EMI.
The right loan isn’t just about the interest rate – it’s about the total cost. Choosing wisely can save you more than you think.
Advantages and disadvantages of flat interest rate loans
Like two sides of a coin, flat interest rate loans have their own set of advantages and disadvantages.
Advantages
- Fixed EMIs: Comfortable for planning, as monthly repayments are same.
- Easy to calculate: Overall interest is set so anyone can comprehend easily.
- Lower interest rate on paper: The rate quoted is lower than in reducing balance rates, but the overall interest paid is more.
Disadvantages
- Higher interest paid: More interest is paid by the borrower over the loan period.
- Not ideal for long-term loans: Since more interest amount is paid, it becomes costly for long repayment periods.
When is a flat interest rate loan appropriate?
A flat interest rate loan is a suitable choice if:
- You require short-term credit (e.g. car loans).
- You like fixed EMIs for improved financial planning.
- The lender gives you a significantly lower flat rate than reducing balance rates.
Why should you choose FIRSTmoney for your personal loan?
If you are seeking a convenient and hassle-free personal loan, FIRSTmoney provides competitive interest rates of 10.99% p.a., with loan sizes between ₹ 50,000 and ₹ 10 lakhs. For convenient financial planning, the borrower can choose between 9 to 60 months as the repayment tenure. The digital loan application process provides quick approvals and disbursals, making borrowing easy. Zero foreclosure charges also allow you to repay the loan on time without additional fees, providing you with higher financial freedom.
Conclusion
Fixed interest rates look attractive because they have a fixed EMI, but they incur more overall interest. A reducing balance rate of interest, such as that provided by FIRSTmoney, is the better choice for long-term loans. Make sure you carefully compare repayment features while choosing a loan to make an informed financial decision.
Frequently Asked Questions
Flat interest rate means the lender calculates interest on the original principal for the entire tenure, rather than on the shrinking balance after each EMI. Even as you repay instalments, the interest portion does not fall proportionately because it is tied to the starting amount. This method shows a lower quoted rate than a comparable reducing method, yet effective cost over time can be higher. Always compare like for like.
A reducing interest rate calculates interest on the outstanding principal after each EMI, so the interest component declines as the balance falls. In a flat method, interest is computed on the original amount for the whole tenure, which keeps the interest part comparatively higher through the journey. Because of this difference, two loans with the same quoted rate can produce different total costs. Always compare effective annual cost before signing up for a loan.
Better depends on total cost, not just the quoted rate. For personal loans, the reducing balance method typically results in a lower outgo than a flat method when the nominal rates match. To compare fairly, convert each offer to an effective annual rate and estimate total interest plus fees over your expected holding period. Include processing charges, insurance, and taxes where applicable, then pick the option that fits your budget.
Under a flat method, total interest equals Principal multiplied by Flat rate multiplied by Tenure in years. The notional EMI equals Principal plus Total interest divided by the number of months. Example: for 1,00,000 at 12 percent for three years, total interest equals 1,00,000 × 0.12 × 3. EMI equals 1,36,000 divided by 36 months. This differs from reducing balance formulas that use PMT and compute interest monthly in spreadsheets.
No, IDFC FIRST Bank offers personal loans on a reducing balance basis, where interest is charged only on the outstanding principal. This means while your EMI stays constant, the effective cost reflects the repayment schedule, tenure, and any applicable fees or taxes.
Direct conversion inside the same contract is uncommon. Many borrowers who want a reducing balance consider refinancing or a balance transfer to a product that uses reducing calculations, subject to eligibility, fees, and timing. Compare the total cost including prepayment or foreclosure charges, new processing fees, and any top up. Use an amortisation calculator to model savings. You can also visit the personal loan EMI calculatorto check the amortisation schedule. Ensure revised terms fit your budget and do not strain monthly cash flow.
Disclaimer
The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.