Personal loan is an unsecured loan, which is very easy to get online. The best thing about personal loans is that you do not have to pay any security in lieu of taking it. Personal loans are approved immediately for online processing, which makes it instant.
One big advantage of personal loans is that the money you get, which you can spend anywhere. There are no fixed limits like home loan or business loan. This means that you can meet your financial needs – in the family, in marriage or emergency.
Fintech companies have made the approval process of personal loans very easy and hassle free for the customers. But the reasons for taking a personal loan can vary. No person wants to take a loan at a higher rate of interest. The same is with personal loans. Interest rates vary from lender to lender. To get a personal loan at low rates, you will have to compare the interest rates of various lenders. But the thing that is important for you to know before starting research, is the structure of the interest rate of personal loan.
Different types of interest rate structure in personal loan
Flat rate structure
When you choose the flat rate structure of a personal loan, the interest on the loan remains the same throughout the term. In the flat rate, the interest is calculated on the entire principal amount plus the annual interest rate.
In the flat rate structure, the interest rate is multiplied with the total loan amount and tenure to find out the total amount paid as interest. Therefore, the interest amount to be paid for your loan is predetermined here.
The total amount to be paid is calculated by this simple formula: P + (P * R * T) / 100 = A.
P is the amount borrowed
R is the interest rate
T is the loan term (in years) and
A is the total amount to be repaid.
Let’s understand this with an example – you have taken a loan of Rs 1 lakh for a period of two years at an annual interest rate of 10 percent.
Here the interest will be calculated as follows:
1,00,000+ (1, 00,000 * 10 * 2) / 100 = 1, 20,000)
The total amount that you will have to pay back here is 1,20,000. This is the amount of 20 thousand interest.
Reducing balance method
Reducing balance interest rate is also called effective interest rate. In this method, the loan interest is calculated on the outstanding loan amount, which remains after the previous deductions.
That is, in this way the amount of interest keeps on decreasing. Taking a loan at a reducing interest rate is considered very beneficial as the total interest cost decreases over time and the burden on the customer also reduces.
Let us understand this with an example:
You took a loan of Rs 3 lakh for 2 years at an interest rate of 12 percent.
Here the EMI of the first month will be 16 thousand rupees, of which the principal repayment is 9000 rupees and the remaining interest is.
Here the interest calculated for the next month will not be on the total amount that was borrowed. Next month interest will be charged on the principal amount – the component of the principal amount paid in the previous EMI. This means that the interest is 3 lakhs – 16 thousand = 2,84,000 rupees.
This means that the interest on your loan for the coming month will be determined by reducing the first monthly instalment paid from the total loan amount.
Keeping these two interest rate structures in mind, you can take a personal loan from the lender according to your need.