How does the type of interest rate (reducing or flat) affect my EMI amount?

The type of interest rate (reducing or flat) significantly affects your Equated Monthly Installment (EMI) amount and the overall cost of your loan. Here's how each type works and its impact on your EMI:

1. Reducing Balance Interest Rate:
Calculation: In this method, the interest is calculated on the outstanding loan balance, which decreases with each EMI payment. As you repay the principal amount, the interest component reduces over time.
Impact on EMI: With a reducing balance interest rate, your EMI remains constant throughout the loan tenure. However, the proportion of principal repayment in each EMI increases while the interest component decreases over time.
Benefit: This method is costeffective because you pay less interest over the loan tenure compared to a flat interest rate. As you continue making payments, a larger portion of your EMI goes toward repaying the principal amount.

2. Flat Interest Rate:
Calculation: In this method, the interest is calculated on the initial loan amount (the entire principal) throughout the loan tenure. The principal amount remains constant, and the interest is fixed.
Impact on EMI: With a flat interest rate, your EMI remains the same throughout the loan tenure. However, this means you're paying a higher interest amount compared to the reducing balance method.
Drawback: While flat interest rates may result in lower initial EMIs, they end up costing more in interest over the loan's lifetime. The proportion of principal repayment in each EMI remains lower, making it less costeffective in the long run.

In summary, if given the choice, it's generally more advantageous to opt for a loan with a reducing balance interest rate. While your initial EMIs may be slightly higher, you'll pay less interest over the course of the loan compared to a flat interest rate. This can result in significant savings in the long term. Always carefully review the loan terms and choose the one that aligns with your financial goals and budget.