When considering a home loan, understanding the interest rate structure is crucial, as it significantly impacts the total repayment amount. Two primary methods of interest calculation are flat interest rate and reducing balance interest rates. Understanding its pros & cons, and key considerations is essential before making a decision.
What is a Flat Interest Rate?
A flat interest rate is calculated on the entire loan amount throughout the loan tenure, regardless of the principal repaid over time. This means the interest remains constant for the entire duration of the loan.
Example:
- Loan Amount: ₹50,00,000
- Interest Rate: 10% (flat)
- Loan Tenure: 20 years
- Interest Payable: 10% of ₹50,00,000 = ₹5,00,000 per year
- Total Interest Payable: ₹5,00,000 x 20 = ₹1,00,00,000
Also Read: CRE Home Loan Interest Rates
What is a Reducing Balance Interest Rate?
A reducing balance interest rate is calculated on the outstanding principal amount after each EMI payment. As you repay the loan, the principal reduces, and so does the interest charged.
Example:
- Loan Amount: ₹50,00,000
- Interest Rate: 10% (reducing)
- Loan Tenure: 20 years
- Interest is calculated on the remaining principal after each EMI, leading to lower interest payments over time.
Also Read: Flat Interest Rate vs Reducing Interest Rate
Comparison of Flat and Reducing Interest Rates for Home Loans
Flat and reducing interest rates differ in how interest is calculated, impacting the total cost of borrowing and EMI structure.
| Feature | Flat Interest Rate | Reducing Balance Interest Rate |
|---|---|---|
| Interest Calculation | Charged on the entire loan amount for the full tenure | Charged on the outstanding principal, which reduces over time |
| EMI Amount | Remains constant throughout the loan tenure | Decreases gradually as principal reduces |
| Total Interest Paid | Generally higher compared to reducing balance | Lower, as interest is calculated on decreasing balance |
| Transparency | Easier to calculate but can be misleading in cost | More accurate reflection of actual interest cost |
| Usage | Common for personal loans, auto loans, hire purchases | Preferred for home loans, business loans, long-term financing |
| Cost-Effectiveness | More expensive over the tenure | More affordable, as interest reduces with payments |
| Best for | Short-term, fixed EMI preference | Long-term loans where lower total interest is beneficial |
Also Read: Home Loan Options to Buy Independent House
Pros and Cons of Flat Interest Rate for Home Loans
A flat interest rate on home loans offers simplicity and fixed EMIs but may lead to higher overall interest costs compared to reducing balance rates.
| Aspect | Pros | Cons |
|---|---|---|
| EMI Amount | Fixed throughout the loan tenure, making budgeting easier | Does not decrease over time, even as the principal is repaid |
| Calculation | Easy to understand and calculate | Less transparent about the actual cost of borrowing |
| Interest Cost | Appears lower in advertisements due to the way it’s presented | Total interest paid is higher compared to reducing balance interest |
| Loan Suitability | Suitable for short-term or fixed-payment loans | Not ideal for long-term home loans due to higher cost |
| Common Use Cases | Used in personal loans, auto loans, and some mortgage plans | Less commonly used for home loans due to higher effective cost |
Read More: Home Loan EMI Calculator With Prepayment
When is a Flat Interest Rate Beneficial?
A flat interest rate can be beneficial for home loans in specific situations where simplicity and predictability outweigh the higher overall interest costs.
- Short-Term Loans: If the loan tenure is short, the difference in total interest paid may be minimal compared to a reducing balance interest rate.
- Fixed Budget Planning: Since EMIs remain constant, it helps borrowers who prefer stable, predictable monthly payments.
- Low-Interest Offers: Some lenders may offer competitive flat rates that make it comparable to reducing balance rates.
- Special Loan Schemes: Flat interest rates are sometimes applied to promotional home loan offers with additional benefits.
- Simplified Calculation: Ideal for borrowers who prefer a straightforward repayment structure without complex calculations.
Which Interest Rate is Better for Home Loans?
The better interest rate depends on the loan tenure, repayment preference, and total interest cost. In most cases, a reducing balance interest rate is more cost-effective for home loans.
| Factor | Flat Interest Rate | Reducing Balance Interest Rate |
|---|---|---|
| Total Interest Cost | Higher, as interest is charged on the full loan amount throughout the tenure | Lower, as interest decreases with each EMI payment |
| EMI Amount | Fixed throughout the loan term | Decreases over time as principal reduces |
| Best for | Short-term loans with fixed repayments | Long-term home loans to save on interest |
| Transparency | Simple and easy to calculate | Slightly complex but more cost-effective |
| Common Usage | Personal loans, Vehicle loans | Home loans, business loans |
- If you want lower overall interest and a cost-effective loan, go for a reducing balance interest rate.
- If you prefer fixed payments and a simple calculation, a flat interest rate may be suitable for shorter loan tenures.
Check Out: Convert Flat to Reducing Balance Interest Rate
Case Study on How a Flat Interest Rate Affects Home Loan Costs
This case study explores how a flat interest rate impacts the total repayment amount for a home loan compared to a reducing balance interest rate, highlighting the cost differences over time.
Example Scenario:
Mr. Arjun, a salaried professional, plans to take a home loan of ₹30,00,000 for 10 years. He is given two interest rate options:
- Flat Interest Rate – 10% per annum
- Reducing Balance Interest Rate – 10% per annum
Comparison of Interest Costs
| Loan Type | Total Interest Paid Over 10 Years | Total Repayment (Principal + Interest) | EMI Structure |
|---|---|---|---|
| Flat Interest Rate | ₹30,00,000 × 10% × 10 = ₹30,00,000 | ₹30,00,000 + ₹30,00,000 = ₹60,00,000 | Fixed EMI throughout tenure |
| Reducing Balance Rate | ₹17,50,000 (approx.) | ₹30,00,000 + ₹17,50,000 = ₹47,50,000 | EMI decreases over time |
Key Findings
- With a flat interest rate, Mr. Arjun pays ₹12,50,000 more in total interest compared to a reducing balance rate.
- The flat interest rate results in fixed EMIs, making budgeting predictable, but costs more in the long run.
- The reducing balance rate lowers the interest burden over time, making it a more cost-effective option for long-term home loans.
Source: Understanding the Calculation of Flat vs Reducing Rate by Economic Times
Home Loan Interest Rates by Top Banks
| Bank | Up to Rs. 30 Lakh | Above Rs. 30 Lakh to Rs. 75 Lakh | Above Rs. 75 Lakh |
|---|---|---|---|
| SBI Bank | 8.50% p.a. onwards | 8.5% p.a. onwards | 8.50% p.a. onwards |
| HDFC Bank | 8.75% p.a. onwards | 8.75% p.a. onwards | 8.75% p.a. onwards |
| LIC Bank | 8.50% – 10.35% p.a. | 8.50% – 10.55% p.a. | 8.50% – 10.75% p.a. |
| ICICI Bank | 8.75% p.a. onwards | 8.75% p.a. onwards | 8.75% p.a. onwards |
| Kotak Mahindra Bank | 8.75% p.a. onwards | 8.75% p.a. onwards | 8.75% p.a. onwards |
| Punjab National Bank | 8.50% – 11.05% p.a. | 8.50% – 11.05% p.a. | 8.50% – 11.05% p.a. |
| Bank Of Baroda | 8.15% onwards | 8.15% – 10.65% p.a. | 8.40% – 10.90% p.a. |
| Bajaj Housing Finance | 8.50% p.a. onwards | 8.50% p.a. onwards | 8.50% p.a. onwards |
| Axis Bank | 8.75%-10.30% p.a. | 8.75%-10.30% p.a. | 8.75%-10.30% p.a. |
| Bank of India | 8.40% p.a onwards | 8.40% p.a onwards | 8.40% p.a onwards |
| TATA Capital | 8.75% p.a. onwards | 8.75% p.a. onwards | 8.75% p.a. onwards |
Home Loan Processing Fees by Top Banks
| Bank | Home Loan Processing Fee |
|---|---|
| SBI (State Bank of India) | 0.35% of the loan amount (min ₹2,000, max ₹10,000) + GST |
| HDFC Bank | Upto 0.50% of the loan amount or Rs. 3300/- whichever is higher |
| ICICI Bank | 0.50% of the loan amount (min ₹3,000, max ₹5,000) + GST |
| Axis Bank | 1% of the loan amount or ₹10,000 (whichever is lower) |
| Kotak Mahindra Bank | 0.5% – 1.00% of the loan amount |
| Bajaj Housing Finance | Up to 4% of the loan amount |
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Conclusion
When it comes to home loans, Reducing balance interest rates are the better choice for home loans, offering lower costs, transparency, and long-term savings. Flat interest rates are simpler but less cost-effective. Always compare options and consult your lender before deciding.
Frequently Asked Questions
Yes, a flat interest rate is legal and commonly used for loans, but borrowers should be aware that it often results in higher total interest costs compared to reducing balance interest rates.
A flat interest rate is a method where interest is calculated on the original loan amount throughout the tenure, resulting in fixed EMIs but higher overall interest costs.
A 10% flat interest rate means interest is calculated on the original loan amount for the entire tenure, rather than on the reducing balance, leading to higher total interest costs.
A reducing balance interest rate is generally better for loans, especially home loans, as it lowers interest costs over time, while a flat interest rate results in higher overall interest but offers fixed EMIs.
The flat interest rate is calculated using the formula:
Interest = (Loan Amount × Annual Interest Rate × Loan Tenure), and the EMI is determined by adding the total interest to the principal and dividing by the number of months.
The flat interest rate is found by dividing the total interest by the product of the loan amount, tenure, and years, using the formula:
Flat Interest Rate = (Total Interest / (Loan Amount × Loan Tenure)) × 100 per year.
The effective flat interest rate is the actual annual interest cost calculated on the original loan amount, without considering principal reduction, making it higher than the equivalent reducing balance rate.
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