When applying for an instant loan, understanding the interest rate charged is considered equally important as checking the loan and repayment tenure. When comparing different offers, borrowers may come across certain terms like fixed interest rate, flat interest rate and reducing balance method and having complete knowledge about them is extremely important.
It makes it easier to estimate the actual cost of borrowing funds and choose a repayment structure that suits your financial condition when you have understood the difference between different interest rates. Whether you apply through a loan app or another digital lending platform, it is important to understand how interest is charged before accepting an offer.
What Is a Fixed Interest Rate?
When the applicable rate remains unchanged and the same during the agreed tenure of repayment, subject to the loan agreement, it refers to the fixed interest rate. A fixed-rate loan offers greater certainty because the EMI remains consistent, helping you manage your finances.
However, a fixed interest rate charged by a personal loan app does not necessarily indicate that a loan is cheaper. Borrowers should also check how the interest is calculated.
Key benefits of a fixed interest rate include:
- Fixed monthly repayment amount
- Easy and convenient financial planning
- No fluctuations in applicable interest rates
- Greater clarity about repayment obligations
What Is a Reducing Balance Method?
Rather than charging interest on the original amount borrowed, in the reducing balance method the interest is calculated only on the outstanding principal amount. The outstanding balance gradually decreases when a borrower repays the principal amount through EMIs, and then the interest is calculated on the remaining sum.
The main features of this method include:
- Interest is calculated on the remaining principal amount
- The main component of the EMI lowers the balance.
- Future interest calculations reflect the remaining loan amount
- The interest burden can decline as the principal is repaid
Fixed Rate vs Reducing Balance: What Is the Difference?
While fixed and reducing balance on an instant loan are often discussed together, they do not mean the same thing. Understanding the difference between the two helps borrowers compare loan offers more accurately.
- When a loan is charged at a fixed rate, the interest amount stays the same from start to end. On the other hand, with a reducing balance, interest is recalculated every month or year, based on the outstanding balance.
- The reducing balance method is considered more affordable than the fixed rate.
- Reducing balance reflects your actual financial obligation, while flat rates can make loans appear more affordable than they genuinely are.
What Should You Check Before Applying?
It is always advised that applicants should not only focus on the advertised interest rate before they choose a loan app. Ensure you review and pay attention to understanding the complete loan terms and repayment structure. Check the following factors:
- Interest Calculation Method: Know whether the platform you’ve opted for is calculating interest using reducing balance or any other method, to avoid future confusion.
- Rate Structure: Learn whether the rate of interest charged is fixed or variable.
- Repayment Tenure: Check whether the platform offers flexibility in choosing repayment tenure, and consider whether the selected tenure affects both EMI and the payable interest rate.
- Processing Fees: Before accepting the instant loan, check all the applicable charges. Including the processing fee.
- Prepayment Terms: Check the conditions applicable to part-prepayment or foreclosure.
- Total Repayment: Rather than just focusing on the monthly payable amount, a borrower must compare the overall amount they have to pay back.
Fixed vs Reducing Rate: Which Is Better?
While both fixed and reducing balance serve two different purposes, there isn’t any universal answer. A fixed rate offers stability in the applicable interest rate, but the reducing balance method evaluates how the interest is calculated on the outstanding amount.
Here are certain factors that will help you understand which instant loan structure will be easier to manage over the repayment period:
- Monthly income
- Existing financial commitments
- Repayment capacity
- Preferred tenure
- Overall cost of borrowing
- Need for predictable EMIs
Why Read the Loan Agreement Carefully?
While choosing a loan from a personal loan app can make borrowing easy and convenient, the quick processing should not replace a careful evaluation. Take your time to understand the details, and before accepting the loan offer:
- Read all the agreements related to the loan.
- Check the interest rate applicable.
- Learn about the structure of the EMI.
- Review processing and other applicable charges.
- Check all the conditions related to prepayment.
- Assess whether the EMI fits your monthly budget.
Final Thoughts
Understanding fixed interest rates and reducing balance calculations enables borrowers to make better-informed borrowing choices. A fixed rate provides predictable repayments, while the reducing balance method calculates interest on the remaining principal as the loan is paid off.
Bajaj Finserv offers eligible borrowers a convenient borrowing experience with no collateral, transparent terms and conditions, quick approval, competitive rates of interest, flexible tenures, and a user-friendly process. Borrowers should always compare the complete terms and repayment costs before choosing a loan app and taking on a new financial commitment.