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Fixed Vs Reducing Balance Loan EMIs-Which is best for you?

November 19, 2012by Basavaraj Tonagatti

Recently one of my client searching for gold loan for his financial need found that one NBFC (Non Banking Financial Companies) offering a better interest rate than banks. In first instance he felt happy that he is getting lesser interest rate than even nationalized banks.

But he shocked when EMI was told to him. Reason was, that NBFC calculated EMI based on fixed interest rate rather than reducing balance method. Hence whenever you go for loan dont concentrate only on interest rate which they offer, instead you need to concentrate on the method of EMI or interest calculation method too.

Usually their are two types of interest calculation methods. One is called Fixed or Simple interest calculation method and another is Reducing Balance method. Let us see with one example which will give more clarity. Suppose you are going for gold loan worth Rs. 25,00,000 tenure will be 1 year and rate of interest 12%.

1) Fixed or Simple Interest calculation method-Now in this method they calculate interest on the principal amount Rs.25,00,000 for the whole tenure of loan which will be Rs.3,00,000 in this case. They add this interest with principal which will be Rs.28,00,000 and divide this amount into 12 equal parts to arrive at your monthly EMI which will be Rs.2,33,333. So in this case you pay Rs.3,00,000 as a total interest for this loan.

2) Reducing Balance Method– In this method also we consider the same values for our calculation. In this method of calculation your EMI will come out to be Rs.2,22,121. In this type of calculation method, every month whatever you pay as EMI, in that principal part is get reduced and on the rest of the amount interest will be calculated and charged you for that month. Hence principal will not be constant in this method, it gradually decreases monthly and at the end of 12th month your principal will be zero. Usually during the start of loan major part will go towards interest and minor part will be towards principal.

From the above two methods with data being same, we noticed that we paid total Rs.1,34,537 high interest than reducing balance method. Hence always dont look at the interest rate part only instead concentrate on the interest calculation method too. Usually such type of fixed or simple interest calculation method loans will offer you lesser interest rates than reducing balance method loans. But ask the difference of interest payment you need to pay then go for the suitable loans.

 

Category: Banking, Real EstateTag: Fixed Rate Loan Calculation, Reducing Balance Calculation method

About Basavaraj Tonagatti

Basavaraj Tonagatti is the man behind this blog. He is SEBI Registered Investment Adviser who is practicing Fee-Only Financial Planning Process and also an Independent Certified Financial Planner (CFP), engaged in blogging since 7 years. BasuNivesh blog is ranked as one among India's Top 10 Personal Finance Blog. He is not associated with any Financial product/service provider. The purpose of this blog is to "Spread personal finance awareness and make them to take informed financial decisions." Please note that the views given in this Blog/Comments Section/Forum are clarifications meant for reference and guidance of the readers to explore further on the topics/queries raised and take informed decisions. These should not be construed as investment advice or legal opinion."

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Reader Interactions

Comments

  1. Prabu

    October 17, 2016 at 4:56 PM

    Dear Sir,

    I am Applying Bike Loan of amount 1,47,838 . And Loan Taken for 3 Years with Flat rate is 10.5% interest and Reducing rate is 18% interest
    Please guide which is preferable for me.

    Reply
    • Basavaraj Tonagatti

      October 17, 2016 at 6:55 PM

      Prabu-They are clever than you. Check which affords you and go ahead if you feel the bike costing Rs.1.47,838 is really a NEED than WANT.

      Reply
  2. Rajesh

    August 3, 2016 at 12:52 PM

    Sir
    I m planing for car loan for 5 yrs
    Ford is giving me 6.99 flat interest rate and icici bank is giving 10.25 reducing interest rate so which is going to be good ford company flat rate or reducing interest

    Reply
    • Basavaraj Tonagatti

      August 4, 2016 at 1:47 PM

      Rajesh-Check why such low rate 🙂

      Reply
  3. Abhishek kaul

    August 1, 2016 at 5:08 PM

    Sir,
    I am takeing a heavy veichle for transport buissenes the loan is of 1450000 rupees for 4 years what should i choose the private finance company whoes rate of flat intrest is of 5.70%/year or bank reducing loan case at 11.50% rate of intrest.

    Reply
    • Basavaraj Tonagatti

      August 1, 2016 at 8:18 PM

      Abhishek-Banks especially nationalized banks.

      Reply
  4. manoj

    July 9, 2016 at 12:21 AM

    Sir mera nam manoj hai. main 6 lakh ka loan lene ka plan kr rha hun. Sbi se 5 years k liye. Rate of interest 12 % Lekin EMI flat lun ya reducing. Isme confuse hun. Lekin interest kam aaye. Sir plz guid me soon….

    Reply
    • Basavaraj Tonagatti

      July 9, 2016 at 2:11 PM

      Manoj-Reducing balance method.

      Reply
  5. dd tandon

    March 13, 2016 at 12:11 AM

    Please give information reducing home loan & floating home loan. What is difrent. My no.-9630998894

    Reply
    • Basavaraj Tonagatti

      March 14, 2016 at 5:46 AM

      Tandon-It is already explained above.

      Reply
  6. yogesh Pawar

    January 18, 2016 at 5:06 PM

    Dear Sir,

    I am Applying Home Loan as amount 17.5 Lac. So please give me example or emi calculate Monthly Details.
    And Loan Taken for 20 Years.

    Also guide which was the prefable for me.

    And which other details check before take a loan…

    Reply
    • Basavaraj Tonagatti

      January 18, 2016 at 5:37 PM

      Yogesh-There are many EMI calculators available online. You can check all the details. It is hard to do it for an individual in comment field. Which was preferable to you means?

      Reply
  7. sanjeevkr

    August 1, 2014 at 1:05 PM

    Sir, i did post graduate diploma in portfolio management. Hence kindly guide me how to b certified financial planner like and from where that degree can be obtained?

    Reply
    • Basavaraj Tonagatti

      August 1, 2014 at 1:59 PM

      Sanjeevkr-Please visit FPSB India website.

      Reply
  8. Saravanan

    June 25, 2014 at 10:08 AM

    Dear Basu,

    Thanks for this clarity in different types of interest calculations.

    I would like to know in case of reducing balance method, how do the calculation made and arrive at a certain EMI? Also what is the calculation for interest and principal proportion during initial days and throughout the loan tenure?

    Please guide.

    Regards,
    Saravanan

    Reply
    • Basavaraj Tonagatti

      June 25, 2014 at 10:40 AM

      Saravanan-Calculation will be exactly like CAGR (compounding). But in the initial stage of your EMI, interest will eat more and as the time passes principal will be at higher but interest part will get reduced as year on year principal get reduced.

      Reply
  9. KRANTI

    November 19, 2012 at 1:36 PM

    Excellent Idea for highlighting these methods.Thank You.

    Reply
    • BasuNivesh

      November 19, 2012 at 8:00 PM

      kranti-Thanks for your comment 🙂

      Reply

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