Types of personal loan interest rates

Personal loans come with two types of rates of interest: Fixed interest rate and floating interest rate.

1. Fixed interest rate
As the name suggests, the interest rate remains the same throughout the loan tenor. Thus, the loan EMIs will also remain constant.

2. Floating interest rate
A floating, adjustable, or variable interest rate is linked to an internal benchmark of a financial institution. Changes to this benchmark will affect the rates. Hence, floating rates vary throughout the loan tenor.

Both of these rates have advantages and disadvantages. Fixed rates keep ENls constant, which helps in budgeting. On the other hand, floating rates go up or come down along with the internal benchmark rate.

Methods for Interest Calculation on Personal Loan

1. Flat rate method
In this method, the applicable rate of interest is charged on the entire principal throughout the tenor.

2. Reducing balance method
In the diminishing balance or reducing balance method, the applicable rate of interest is chargeable on the outstanding principal after each EMI is paid off. Thus, the interest is calculated every month on the loan balance. Borrowers pay lower interest on the loan compared to the flat rate method.

Interest rate calculation formula

The interest rate for a personal loan through the flat rate method and the reducing balance method is calculated using the following formula:

1. Flat rate method
The rate of interest is chargeable on the entire loan principal. The formula for this method is — ENI = (principal + total interest payable) / loan tenor in months Wherein, total interest payable = P x r x n/100