It has become common to live with credits. Every person has a debt of something or the other. Whether it is home loan, car loan, personal loan, education loan, gold loan or loan against property. Actually, taking a loan has become easier now and it is achieved in a few hours. Online lenders have made loan processing so easy that we apply for the loan without understanding all its aspects. Loan agents or bank employees never tell you the negative aspects of a loan. Apart from this, we do not give detailed information about the conditions. In this article, we will tell you how you can avoid big loan wiring.
This thing is known to all customers that the amount we take as loan from the bank returns it to the bank with a certain interest. Today we will tell you the ways through which the borrower can calculate the interest on the loan. Many times, lenders do not tell customers about the procedures that they can benefit from. Let us tell you how you can save yourself from the trap of lenders.
Interest on the loan can be calculated in two ways. The first is Flat Interest Rate and the second is Reducing Balance Interest Rate.
What is Flat Interest Rate?
Flat interest rate means that the interest that will be charged on the loan will remain the same throughout the period, never change. It also means that till the end of the period, the interest rate will be calculated on the entire principal amount. In this process of interest calculation, the principal and interest remain the same till the last EMI of the loan. With every EMI, the principal amount is paid, but calculating the interest at the flat interest rate is also calculated on the principal amount that has been paid.
How to calculate flat interest rate
Interest paid per instalment = (real loan amount * how many years * interest rate per year) / number of instalments
Suppose you have taken a loan of Rs 1 lakh and the flat rate of interest is 10 percent for 5 years (60 months), then you will have to repay:
20000 rupees (principal repayment @ 100000/5) + 10000 (100000 interest @ 10%) = Rs 30000 every year or Rs 2,500 every month.
In this way, you will pay Rs 2500 * 60 = Rs 150000. Hence the payment of Rs 2500 per month translates into an effective interest rate of 17.27% per annum on your loan.
The above mentioned calculation shows that while choosing a loan at flat interest rate, the effective interest rate is 1.7 to 1.9 times higher than the interest rate on our loan agreement papers.
What is Reducing Balance Interest Rate?
The Reducing Balance Interest Rate is calculated every month on the outstanding loan amount. In such interest, the EMI includes the interest payable for the outstanding loan amount for the month. The outstanding principal amount decreases with each EMI. Therefore, the interest payable for the next month is calculated on the Unpaid Principal Amount. Reducing balance interest rate is done on home loan, mortgage loan, loan against property, loan overdraft, credit cards etc.
Formula for calculating reducing balance interest rate
Interest to be paid per install = Interest paid on each instalment * Remaining loan amount
Let us understand this from the earlier example. You took a loan of 1 lakh rupees for up to 10 percent interest for 5 years (60 months). In a Flat Interest Rate loan, a person has to pay Rs. 10 thousand per month till the end of the loan term. But in the Reducing Interest Rate loan, the EMI of the first month will be 10 thousand, the second month will be 8000 rupees. That is because after paying the first EMI, your outstanding principal amount will be reduced to 80 thousand rupees. In this way, the interest rate on EMI will decrease every month. In this way, you will have to pay only 1.3 lakh rupees from the loan of Reduced Interest Rate, whereas you are paying 1.5 lakh rupees from the flat interest rate.
Keep these things in mind
You must have understood from the above calculation that how the Flat Interest Rate is nothing but a trap. This is just a way to entice customers. Banks tell customers only about its features. These spiders are such that the customer is stuck in it for the entire loan period and he does not know that he is trapped. When people need money, they do not have time and patience to understand the terms of the loan. In such a situation, they fall into this trap of the lender.
So whenever it comes to taking a loan, you must give time and calculate how much amount you are paying for the loan. By making wise decisions, you will not be caught in the trap and will also be able to save money.