Flat Interest Rate vs Reducing Balance Interest Rate Calculator 2024

Flat Interest Rate vs Reducing Balance Interest Rate Calculator

Calculate Flat Interest Rate vs Reducing Balance Interest Rate Calculator to Compare monthly EMIs and total interest payments and make informed decisions on the most cost-effective and suitable loan structure.

Reducing Rate EMI Calculator

Interest Rate Calculator

Principal Amount:
Interest Rate (%):
Loan Tenure (months):
Calculate Flat Interest Calculate Reducing Balance

How to Use Flat Rate Vs Reducing Interest Rate Calculator

1. Enter the Loan Amount: Type in the total loan amount you want to borrow. This will be the principal sum that both the flat and reducing interest rate calculations will be based on.

2. Type in Loan Tenure: Next, enter the loan duration in years or months, depending on your preference. You must know that both methods will have a separate calculation for their respective interest rates based on the loan tenure.

3. Fill in Flat Interest Rate: Now, provide the flat interest rate (%) your lender offers. It’s crucial to double-check this figure since flat interest rates could make repayments seem low when, in reality, they may not be the most cost-effective option.

4. Input Reducing Balance Interest Rate: Likewise, enter the reducing balance interest rate (%). Reducing balance interest rates is often preferred since the interest is calculated on a diminishing principal, making it more cost-efficient.

What is a Flat Interest Rate?

A flat interest rate is an interest calculation method where the interest stays the same throughout the loan tenure. The interest is calculated on the initial loan amount for the entire tenure, without considering any changes in the outstanding principal amount.

Let me explain to you with an example.

1. For Loan Amount = 15,000:
   • Interest Payable: 50,000
   • Number of Months: 60
   • Loan Amount: 15,000
   • Flat Rate = (50,000 / 60) * 1200 / 15,000
   • Flat Rate = 40%
2. For Loan Amount = 90,000:
   • Interest Payable: 50,000
   • Number of Months: 60
   • Loan Amount: 90,000
   • Flat Rate = (50,000 / 60) * 1200 / 90,000
   • Flat Rate = 6.67%

Basically, it means you pay the same interest amount each month, no matter how much of the loan you already paid off.

Here’s an example to help you understand better:

• Suppose you take a loan of $10,000 with a flat interest rate of 10% for a term of 3 years.
• The total interest amount for the entire term would be $3,000 (10,000 x 10% x 3).
• Your monthly repayment would consist of the same interest amount ($3,000 ÷ 36 months = $83.33) plus part of the principal amount.

What is Reducing Balance Interest Rate?

The reducing balance interest rate is an interest calculation method where the interest on your loan is computed based on the remaining balance after each EMI (Equated Monthly Instalment) payment.

I will use the same example as above.

1. For Loan Amount = 15,000:
   • Interest Payable: 27,482
   • Number of Months: 60
   • Loan Amount: 15,000
   • Reducing Rate = (27,482 / 60) * 1200 / 15,000
   • Reducing Rate = 7.29%
2. For Loan Amount = 90,000:
   • Interest Payable: 27,482
   • Number of Months: 60
   • Loan Amount: 90,000
   • Reducing Rate = (27,482 / 60) * 1200 / 90,000
   • Reducing Rate = 1.09%

Pretty simple, right?

This way, the interest rate keeps going down as the outstanding loan amount is reduced, making things lighter in your pocket!

You might wonder what sets this method apart from the flat rate interest.

Well, let me share some insights. In the flat rate method, interest is calculated on the principal loan amount throughout the entire loan tenure, whereas in the reducing balance method, the interest charged is on the outstanding loan amount, which changes after every EMI.

Some advantages of the reducing balance interest rate include:

• Lower overall interest costs compared to the flat rate method
• Interests charged are decreasing over time, making the financial burden lighter

How to Calculate Flat Rate Interest?

Step 1: Get Your Loan Details

First things first, you’ll need the following details of your loan:

• Loan amount
• Loan tenure
• Flat interest rate (%)

Step 2: Calculate the Total Interest

Here’s a simple formula to calculate the total interest over the loan tenure:

Total Interest = (Loan Amount × Loan Tenure × Flat Interest Rate) / 100

For example, if you have a loan amount of $10,000, a loan tenure of 5 years, and a flat interest rate of 7%:

Total Interest = ($10,000 × 5 × 7%) / 100 = $3,500

Step 3: Calculate the Monthly Instalment

Now that we have the total interest, let’s determine the monthly installment:

Total Repayable = Loan Amount + Total Interest

Monthly Instalment = Total Repayable / (Loan Tenure × 12)

Continuing with the example:

Total Repayable = $10,000 + $3,500 = $13,500

Monthly Instalment = $13,500 / (5 × 12) = $225

Calculation of Reducing Balance Interest

Here’s a step-by-step breakdown on calculating reducing balance interest:

1. Identify outstanding principal: Start by noting down the remaining principal balance after each EMI payment.
2. Calculate interest: For each installment, multiply the outstanding principal by the annual interest rate and divide this by 12 months to get the monthly interest amount.
3. Determine principal repayment: Subtract the interest calculated in the previous step from the total EMI to ascertain the principal repayment for that installment.
4. Update outstanding principal: To get the new outstanding principal balance, subtract the principal repayment from the previous step.
5. Repeat steps 2-4: Continue the calculation for subsequent months until the entire loan amount is repaid.

Examples and Scenarios

Flat Interest Rate Example

Let’s take a look at a flat-interest rate loan scenario. Imagine you are taking out a loan of $1,000 with a 5-year loan tenure and an interest rate of 10% per annum. What does that mean for you?

Well, to help with that, consider using an EMI calculator.

Under a flat rate system, the interest amount is calculated on the original loan amount (also known as the principal) throughout the entire loan tenure:

Interest Amount = (Principal Amount × Interest Rate × Loan Tenure) / 100

For our example:

Interest Amount = ($1,000 × 10% × 5) / 100 = $500

So, you will be paying a total of $1,000 (principal amount) + $500 (interest amount) = $1,500 over 5 years.

Your monthly installments will be:

Instalment Amount = Total Payable / Number of months
Instalment Amount = $1,500 / 60 = $25

Thus, with a flat interest rate, your monthly installments remain constant at $25.

Reducing Balance Interest Rate Example

Now, let’s check out an example with a reducing balance interest rate scenario. Assuming the same loan amount of $1,000, a 5-year loan tenure, and a 10% per annum interest rate:

Under the reducing balance system, the interest amount is calculated on the outstanding loan balance after each payment, which progressively reduces as you pay off the principal:

Interest Amount = Outstanding Principal × Interest Rate / 12

For the first month:

Interest Amount = $1,000 × 10% / 12 = $8.33

After the first month, your outstanding principal reduces to:

Outstanding Principal = Initial Principal – (Instalment Amount – Interest Amount)
Outstanding Principal = $1,000 - ($25 - $8.33) = $983.33

In the second month:

Interest Amount = $983.33 × 10% / 12 = $8.19

You’ll notice a decrease in the interest amount to be paid. This trend continues until the end of your loan tenure.

Consequently, in the context of reducing the balance interest rate, your effective interest rates are lower than their flat rate counterparts, saving you more over the long run.

Frequently Asked Questions

How is the interest on a reducing balance loan calculated differently than on a flat-rate loan?

When it comes to a reducing balance loan, the interest is calculated on the outstanding principal balance, which means it decreases as you keep repaying the loan. On the other hand, a flat-rate loan charges interest on the original loan amount, making it constant throughout the entire loan period.

Can you demonstrate the difference in cost between a flat interest rate and a reducing balance interest rate with an example?

Let’s say you borrow $10,000 at a 10% interest rate for a 3-year term. With a flat interest rate, the total interest would be ($10,000 x 10% x 3) = $3,000. So, you’d pay $13,000, spread over 36 equal monthly installments.

However, with a reduced balance interest rate, the interest is calculated on the outstanding balance every month. As you pay down the principal, your interest decreases. The total interest will be less than that of a flat-interest rate loan, resulting in a more cost-effective loan option.

What are the advantages and disadvantages of choosing a flat interest rate over a reducing balance interest rate?

A primary advantage of a flat interest rate is its simplicity in calculation and understanding. They can also be suitable for short-term loans or in-kind loan transactions.

They have a significant disadvantage: you pay more interest overall when compared to a reducing balance interest rate loan. With reducing balance loans, your interest decreases as you repay the principal, making it generally more cost-effective in the long run.

In terms of monthly payments, how does a flat rate interest EMI differ from a reducing balance interest EMI?

Monthly payments for flat-rate interest loans remain the same throughout the loan period because the interest is calculated on the original loan amount. With reducing balance interest loans, your Equated Monthly Installment (EMI) may decrease over time, as the interest is calculated on the outstanding principal balance, which reduces as you repay the loan.

Which loan interest calculation should you opt for to save more in the long term, flat interest rate or reducing balance interest rate?

To save more in the long term and pay less interest, it’s typically better to opt for a reducing balance interest rate loan. Though the calculations can be a bit more complex, this type of loan allows you to pay less interest compared to a flat-interest rate loan.

Note that it’s always crucial to compare different loan options and consider your unique financial situation before making a decision.