A personal loan is an unsecured loan which is fairly easy to qualify for and obtain since it is available online. The best part about availing a personal loan is, it does not require you to pledge any collateral against your borrowing. Personal loans are even been offered with instant approval through online processing which makes it instant.
A major benefit of taking a personal loan is that the money you get from the loan can be spent without any limitations unlike a home loan or business loan. This means you can use the money to meet any 0of your financial requirements – from financing a family wedding to meet your emergency requirements.
FinTech companies have made personal loan sanctioning process simple, hassle-free and convenient for the customers. However the reason to avail a personal loan can vary, but no one would like to go for a loan with a high-interest rate. The same is true with a personal loan, the interest rate charged against it varies from lender to lender. While to have a personal loan on the best interest rate you need to do a lot of research among the different lenders offering a personal loan in the market. Well, there is one more important thing which you need to know before you start your research- and that is the structure of your personal loan interest rate.
Types of Interest Rate structure offered for Personal Loan
Flat Rate Structure
When you opt for a flat-rate structure for your personal loan, the interest for your loan remains constant throughout the tenure. For a flat rate, interest is calculated on the entire principal and the annual rate of interest associated with that.
Under the flat-rate structure, the interest rate is multiplied with the total loan amount and tenure period to know the total amount paid as interest. Hence, the interest amount to be paid for your borrowing is predetermined here.
Or the total amount to be paid is calculated by the simple formula: P+ (P*R*T)/100= A.
P is the amount borrowed,
R is the rate of interest,
T is the tenure period in years, and
A is the total amount to be repaid.
Let’s take an example to understand it – You have a loan ₹ 1, 00,000 at the rate of 10 % per annum) for 2 years.
Here your interest will be calculated as-
₹1, 00,000 + (1, 00,000*10*2)/100 = ₹1, 20,000
So, the total amount to be repaid is ₹1, 20,000. Where 20,000 is the total interest amount.
Reducing Balance Method
Reducing balance interest rate is also known as the effective interest rate. Under this method, the interest for a loan is calculated on the outstanding loan amount, which is the amount left to be repaid after the previous interest deduction.
So under this interest rate every time, the interest amount to be paid reduces gradually. Taking a loan on reducing interest rate is more beneficial for the borrower as the total interest cost reduces with time which reduces the burden of the borrower as well.
Let us understand this with an example-
Suppose you take a loan of ₹3,00,000 at an interest rate of 12% p.a. and the tenure period is 2 years.
Here the EMI for the first month will be ₹ 16,000 out of which principal repayment is ₹ 9,000 and interest remaining is the interest.
Here the interest calculated for the next month will not be on the total amount which was borrowed. For next month the interest charged will be on the principal amount – the component of the principal amount paid in the previous EMI. Which means interest will be charged on ₹3,00,000 – ₹16,000= ₹ 2, 84,000.
This means the interest on your loan for the coming month will be determined by reducing the first monthly instalment paid from the total loan amount.
Considering these two interest rate structures you can choose your personal loan provider as per your requirement.