Flat interest rates and reducing interest rates serve as two unique approaches to calculating interest on a loan. When using the flat rate of interest, the calculation of interest is performed on the entire loan throughout the loan period. Note that the interest amount stays constant all through the loan period. Every instalment payment incorporates a portion of the principal amount and the fixed interest. This flat interest rate method is easier but can be costly over time since it doesn’t consider the gradually decreasing principal amount as you gradually repay the loan.
The reducing rate of interest calculates interest only on the remaining principal amount. It is calculated at the end of each period, usually monthly. The principal amount reduces as you pay off the loan; the interest charged on it also reduces simultaneously. This method can lead to reduced total interest payments throughout the loan tenure, unlike a flat interest rate.
Typically, a flat rate of interest is higher than reducing rate of interest. It is commonly used by vehicle finance firms. Understanding the flat vs reducing interest rate calculator helps you to make a choice effectively. The choice between these two methods can considerably impact the overall sum of interest to be paid. Hence, it is vital to understand both these concepts when you are taking a loan.
The choice between flat and reducing interest rates can significantly affect the total amount of interest you pay, so it’s important to understand these concepts when considering a loan.
The formulas help you to better understand the flat vs reducing interest rate calculator.
Here’s the formula to calculate a flat interest rate:
Total Interest = (P * I * T)/100
where,
Total amount repayable = P + (P * I * T) /100
Monthly EMI = ( P + (P *I* T)/100) / T*12
To calculate a reduced interest rate, you need the EMI amount, which is calculated as follows.
EMI = [P x Ix (1+I) ^T]/ [((1+I) ^T)-1)]
where,
The formula to calculate the reduced interest rate is as follows:
Reduced interest rate = Monthly EMI x T – P
The following example helps you comprehensively understand the flat vs reducing interest rate calculator.
Suppose you have borrowed INR 10,000 at a 10% interest rate for 5 years. With a flat interest rate approach, you would pay interest on the whole principal amount (i.e. INR 10,000) for all 5 years.
If you use a reducing interest rate approach, you would pay 10% interest on the reduced balance every year. As you gradually pay off the principal amount, the interest for the succeeding years is calculated on a reduced amount.
The flat vs reducing interest rates calculator serves as a financial tool to compare the total interest to be paid on loans provided at flat interest rates vs reducing interest rates. It aims to assist borrowers in understanding the effect of various interest rate structures on the total borrowing cost over the loan period.
In the flat vs reducing interest rate calculator, users need to fill in the loan details like the loan amount, loan tenure and interest rate. After inputting these details, the calculator calculates the total interest to be paid for both reducing and flat interest rates. Consequently, borrowers can effectively compare the total borrowing cost under each method.
You can follow the below steps to use the ClearTax flat vs reducing interest rates calculator:
This tool lets you compare the total interest you need to pay under each structure (reducing interest rate and flat interest rate). So you can assess the viability of various loan options.
Understanding the benefits helps you to better assess the difference between flat vs reducing interest rate calculator. Here are the benefits: