# Fixed Vs Reducing Balance Loan EMIs 2022

When choosing a loan, whether it is a home loan, personal loan, vehicle loan, educational loan or any other, you will be presented with two types of Equated Monthly Instalments (EMI). These are the fixed or flat interest rate EMI and the reducing interest rate EMI. It helps to understand what these are, the differences between the two, and the pros and cons of each before you choose so that you will make the best decision for your specific requirements.

## Fixed Interest Rate EMI

A fixed or flat rate EMI is one where the lending rate, or interest, remains unchanged throughout the tenure of your loan. The interest for the entire loan tenure will be calculated at the start of the tenure itself.

## Formula for Calculating Fixed Interest Rate EMI

The formula for calculating the fixed interest rate EMI is as given below:

Interest to be paid on each instalment = (Loan principal amount x total tenure of the loan x interest rate per annum)/sum total of instalments

### Reducing Balance EMI

Reducing balance EMI is also called reducing balance interest rate or diminishing interest rate. Here the interest amount accrued will vary depending on the principal loan amount that is outstanding based on the effective lending interest rates.

## Formula for Calculating Reducing Balance Interest Rate EMI

The formula for calculating the reducing balance interest rate EMI is as given below:

Interest to be paid on each instalment = The remaining loan amount x the interest rate that is applicable for each instalment

## Difference between Fixed Interest Loan and Reducing Balance Loan

The differences between a fixed interest rate EMI and reducing balance EMI based on various parameters are as given below:

• Interest rate: Loans with fixed rate of interest generally have lower rates of interest than loans with reducing balance.
• Interest rate calculation: The interest rate calculation for a fixed interest loan is simpler than that of a reducing balance loan.
• Amount on which interest is calculated: For a fixed interest rate loan, the calculation will be based on the total amount sanctioned whereas for a reducing balance loan it will be based on the principal amount that is outstanding.
• Loan tenure: The loan tenure of a fixed interest loan will usually be longer than that of a reducing balance loan.

## Pros and Cons of Fixed vs Reducing Balance Loan EMIs

Before deciding which is the best type of EMI to choose for your loan, it helps to understand the pros and cons of each of the two types. Here are some pointers based on certain parameters:

Advantages of fixed interest rate loans: The monthly amount to be paid does not change with time, which can help to manage and plan your monthly budget ahead of time. The interest rate on such loans is lower which is beneficial for those with lower loan eligibility. The repayment tenure is longer which can help with more flexibility in repayment.

Disadvantages of fixed interest rate loans: You will be paying the same interest rate throughout the tenure of the loan even if lending rates are reduced by the bank. The EMI amount may also be higher.

Advantages of reducing balance Interest rate: The interest paid on a reducing balance loan reduces over time since it is calculated on the principal amount that is outstanding, hence theamount of interest paid will gradually become lesser than that of a fixed interest loan.

Disadvantages of reducing balance interest rate: The interest rate calculation is more complicated.

## Calculation of Fixed vs Reducing Balance EMI

Let’s understand the fixed/flat interest calculation method and the reducing balance methodwith an example using the following parameters:

• Loan worth is Rs. 25,00,000
• Loan Tenure is 1 year
• Rate on interest is 12%

## Fixed or Simple Interest Calculation Method:

As per this method the interest is calculated on the principal amount. In this case it is Rs.25,00,000. The method is used to calculate the interest for the entire tenure of loan. In this case it will be Rs.3,00,000. The interest arrived at will be added to the principal (which will be Rs.28,00,000). This will further be divided into 12 equal parts to arrive at your monthly EMI. In this case it will be Rs.2,33,333. The total interest to be paid, in this case is Rs.3,00,000.

## Reducing Balance Method:

Considering the same value for loan amount, interest rate and loan tenure, we will calculate the EMI amount arrived at, according to the reducing balance method. The EMI, post calculation, comes to Rs.2,22,121. As per this mode of interest calculation, whatever you pay towards your monthly EMI gets reduced in that principal part. Apart from this, interest will be calculated on the rest of the amount and you shall be charged for that month. So it is understandable that the principal will not be constant in this method. It decreases gradually, on a monthly basis, and at the end of 12th month the principal stands at an amount of zero. Please note that during the initial stages of the loan, the major part goes in interest and minor part goes towards principal.

Keeping the basic data same and calculating the interest with two different methods, it can be seen that the simple/fixed interest calculation method demanded a total of Rs.1,34,537 high interest than reducing balance method. This explains why it is important to look at the interest calculation method, and not just the interest rate offered. It is true that such type of simple or fixed interest calculation method loans provide you a lower interest rate than that of reducing balance method loans. Therefore, make sure that you ask the loan provider the detailed difference in interest payment, and only then decide to avail the loan. A good choice of loan provider will not only fulfil your financial needs, but also be easy on your pocket.

## FAQs

1. Which is better – fixed or reducing balance EMI?
2. Making the choice of a fixed or reducing balance EMI should be done keeping in mind your financial requirements and repayment capacity. A fixed EMI will usually have lower rates of interest and longer repayment tenure but a higher EMI with interest that is fixed throughout the loan tenure and calculated on the entire loan amount. A reducing balance EMI may have lower EMIs and shorter repayment tenure because the interest rate will vary and is calculated on the principal amount outstanding, which will be reducing over time.

3. What decides the interest rate in a reducing balance EMI?
4. The interest rate in a reducing balance EMI depends on the lending rates of the bank which in turn will be influenced by repo rates set by the Reserve Bank of India (RBI). This will in turn depend on various economic scenarios, both domestic and global.

5. How to calculate EMI for the entire loan tenure before taking the loan?
6. It helps to understand what your EMIs will be for your entire loan tenure before taking the loan. While this can be done with a manual calculation, it is best to do it with one of the free online EMI calculators that will give you a detailed amortisation schedule for your entire loan tenure based on your loan amount, loan tenure, and interest rate.

## News About Fixed Vs Reducing Balance Loan EMIs

• ### Financial Markets Being Closely Monitored by SEBI and RBI

The financial markets and the recent developments therein are being closely monitored by the Securities and Exchange Board of India and the Reserve Bank of India. Both institutions are set to take appropriate actions if needed, according to Jose J Kattoor, the Chief General Manager of the Reserve Bank of India. The notification from the Reserve Bank of India came following volatility that was recently witnessed in financial markets. The value of the Indian rupee has depreciated against the value of the US dollar in the past few weeks. As a result, financial markets have been adversely affected. Despite the value of the rupee improving slightly, the government in power has received a lot of flak from people who were affected by the volatility. Even opposition parties were quick to blame the government before the Reserve Bank of India and the Securities and Exchange Board of India stepped in to monitor the markets.

27 September 2018

• ### Interest rate setting panel of Reserve Bank of India begin 3 day meet

The Monetary Policy Committee consisting of 6 members headed by the Governor of the Reserve Bank of India Urjit Patel have started the three day deliberations in order to decide the key interest rate amid an increasing inflation rate and increasing oil prices. Many of the experts have a divided opinion on whether the Reserve Bank of India will increase the benchmark lending rate. The Monetary Policy Committee is all set to meet for the third bi-monthly Monetary Policy Statement for the 2018-19 financial year. The resolution of the Monetary Policy Committee will be announced to the public on August 1 in the afternoon. The repo rate was increased by 0.25 percent in the last policy review in the month of June citing inflation concerns. The retail inflation which is also factored by the Monetary Policy Committee has now reached a five month high and currently stands at 5 percent owing to the increase in the fuel prices. According to some experts, the increase in the minimum support price of the Kharif crop will have a significant impact on the inflation. While the price of crude oil has come down from the three year high, the prices of crude oil continue to remain volatile and continue to threaten the inflation. The State Bank of India has said that the Reserve Bank of India might not go for another round of rate hiking at this time, according to a research report.

1 August 2018

• ### Taxation of Life Insurance Money

The nominee of a policyholder is not taxed in case of the policyholder’s demise. The proceeds will be sent to the nominee upon the death of the insured. However, if the policy falls under the category of Keyman policy, the proceeds will be subject to tax. Life insurance policies that are availed between the 1st of April 2003 and the 31st of March 2012, tax will be charged in case the premiums applicable to the policy are more than 20% of the sum assured. The tax rate applicable will be marginal. Life insurance policies availed after the 1st of April 2012 will attract tax if the premium payments applicable to the policy are more than 10% of the sum assured.

3 July 2018

• ### NBFC License Granted by RBI to Cox & Kings Financial Service

Cox & Kings’ fully-owned subsidiary, Cox & Kings Financial Service Ltd. has received a Non-Banking Financial Company (NBFC) license from the Reserve Bank of India (RBI). Exchanges have been informed by Cox & Kings that Cox & Kings Financial Service Ltd. intends on carrying on the business of student loan financing and holiday financing along with other non-banking financial service activities as well as a foreign exchange business.

4 June 2018

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