How to Choose a Personal Loan Lender Based on Interest Rate Structure?

Updated on: 14 Dec 2021 // 23 min read // Personal Loans
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Gone are the days when you had to resort to borrowing money from friends, family, or crooked money lenders. With the FinTech boom, things have transformed at a rapid pace. You can now avail of a Personal Loan for any financial requirement that you may have within a few hours.

Whether you want to spend for an overseas vacation, destination wedding, higher education, or a medical urgency, you can avail of Personal Loan for any urgent or unavoidable expense. Some of the most popular personal loans presently in the market are HDFC Personal Loan, Bajaj Finserv Personal Loan, Shriram Finance Personal Loan, and SBI Personal Loan.

Personal Loan is unsecured in nature, and therefore you need not offer any collateral to secure the loan amount. Moreover, there is no need for any lump sum payments, as the loan amount has to be repaid in EMIs. With the fierce competition in the market, you can now enjoy extremely attractive Personal Loan interest rates for your requirement.

There are some more useful features of personal loans, which have been elaborated below:

Personal Loan Online

Features of Personal Loans

While the specific features of a Personal Loan vary according to the lender, the following are the key features that are common across the spectrum: –

  • Customers can avail high-value Personal Loans up to Rs. 40 Lakhs without offering any collateral.
  • Maximum repayment tenor can extend up to 72 months, making the EMIs more affordable.
  • Personal Loan interest rates start from as low as 10.99%, making them suitable for all requirements.
  • Processing charges can be as low as 1% of the loan amount.
  • Flexible Personal Loan eligibility criteria are followed by lenders while assessing the applications.

Personal Loan Interest Rates

One of the most important factors that can affect your decision regarding the suitability of a Personal Loan offer is the interest rate. Personal Loan interest Rates vary across lenders, and you must, therefore, undertake detailed research to identify the best offer. During your research, you will compare various factors like the applicable rate of interest, penal interest, other charges, etc. But there is one aspect of a Personal Loan interest rate that you need to pay particular attention to, and that is the Interest rate structure.

Selecting a lender based on the interest rate structure

The interest rate structure offered by your lender can have a significant bearing on the total interest cost that you will have to serve during the repayment tenor. Presently, there are two types of structures that are followed by lenders, i.e.:

  • Flat Rate Structure
  • Reducing Balance Rate Structure

While most lenders in the market use only reducing balance rate structure to prepare the loan repayment schedule, there are a few who offer flat-rate structure.

Flat rate structure

When you avail of a Personal Loan under the flat-rate structure, the interest component and the principal component of the EMI will remain same during the entire repayment tenor. This is because the interest based on a flat rate structure is based on the total amount borrowed and the rate of interest applicable against it.

The formula used to calculate interest liability under flat-rate structure is:

P x R X T/100 = A


P is the principal amount that you actually borrowed

R is the rate of interest applicable to the loan

T is the time period of the loan in years

A is the total interest you will pay during the repayment of the loan

For instance, if you avail a loan of Rs. 5,00,000 for a period of 5 years at an interest rate of 12% per annum, the total interest you will have to pay by the end of repayment tenor is

5,00,000 x 12 x 5/100 = Rs. 3,00,000

This means, you will have to repay Rs. 8,00,000 over 5 years, therefore your EMI would be 13,333.33 wherein the principal component would be Rs. 8,333.00 and interest component would be Rs. 5,000.00 during the repayment tenor.

Reducing Balance Rate Structure

When you avail a Personal Loan under reducing balance rate structure, your interest and principal liability are recalculated every month, while the EMI amount remains the same. The interest is calculated on principal amount outstanding after paying the last month’s EMI. Under this structure, when the repayment starts, the interest component in the EMI is higher than the principal component, and this trend reverses over the repayment tenor. Eventually, by the time the repayment tenor is about to be finished, you are virtually repaying only the principal component. 

Let’s analyse the Reducing Balance Rate Structure with the same example. For a loan amount of Rs. 5 Lakh Borrowed at 12% per annum for a period of 5 years, your EMI would be Rs. 11,122. The total principal to be repaid remains the same at Rs. 5 Lakhs while the total interest paid would be Rs. 1,67,334. Thus, you will be repaying only Rs. 6,67,334 over a period of 5 years as compared to Rs. 8 Lakhs under the flat-rate structure. A difference of Rs. 1,32,666.

The simple concept behind this calculation is that as the principal amount reduces, the interest liability reduces every month. Whereas, under the flat-rate structure, it remains same throughout as the interest was calculated at the beginning of repayment itself.

From the above analysis, it is evident that opting for a reducing balance structure is far more beneficial as compared to a flat rate structure as you have to serve lower EMI amount every month, and your total interest payments are significantly lower. So, the next time you are availing a Personal Loan, opt for a reducing balance rate structure.

Also read: Bajaj Finserv Personal Loan or HDFC Bank Personal Loan-Which is Better?

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