Looking for a small business loan to grow your business? You may need to compare various products and lenders before choosing one that’s best suited to your requirements! Aside from the loan interest rates, how the interest is calculated also plays a huge role in the cost of financing.
Let’s look at the two ways the interest rate for small business loans is calculated, and which one is ideal for you!
Flat Rate VS Reducing Balance Method Of Small Business Loan Interest Rate Calculation
Here’s a quick comparison between the flat rate and reducing balance methods of interest rate calculations for small business loans.
1. Flat Rate Method:
In this case, the business loan interest rate is calculated on the initial principal amount without accounting for the principal repaid. This method of interest calculation results in a higher EMI.
For eg. Let us assume you take Rs. 1,00,000 loan at 10% interest rate. The interest component for every year would be 10,000.
So in case you would like to repay the loan in 3 years, the total of the principal amount and the interest rate would be Rs 1,00,000 + Rs, 30,000 i.e. Rs 1,30,000. Spread over a period of 3 years, you’d have to pay Rs. 3612 per year.
2. Reducing Balance Method:
In this case, the business loan interest rate is calculated on the principal amount outstanding at the end of a specific period.
With every EMI paid, there is a certain portion that is adjusted against the principal and the balance goes towards interest.
While calculating the interest, the next calculation is on the principal balance outstanding and not the initial principal amount.
For eg. Let us assume you have a loan amount of Rs. 5,00,000 with an interest rate of 15% which needs to be repaid in 5 years.
The EMI, in this case, would be Rs. 11,895 per month. In the 1st year, you pay a total EMI of Rs. 1,42,740 of which Rs. 72,596/- goes for interest and the balance Rs. 70,144 goes towards interest.
Now the interest rate is calculated at 15% only on the balance principal amount i.e. Rs. 4,37,404. Using this method if you have the ability to pay larger amounts as part payment, you will reduce your interest paid.
Which One To Choose?
Let’s look at the differences between fixed interest and reducing balance loans to understand which one would be more suitable for you!
- The interest rates offered for Fixed Interest Loans are generally lower than that of the Reducing Balance Loans.
- Since the interest paid for the Reducing Balance Loan reduces over time, the amount of interest paid for this type of loan is generally less than that for a Fixed Interest Loan.
- The loan tenure of a Fixed Interest Loan is usually longer than that of the Reducing Balance Loan.
Choose the type of business loan that suits your needs!
For unsecured business loans, get in touch with Gromor Finance today!