What is effective interest rate in Personal Loan?

When you apply for a personal loan, the lender will want to see that you have a solid credit score and enough money saved up to cover the entire amount of the loan. However, what is an effective interest rate for a personal loan? How does this rate impact your ability to get approved for a loan?

Effective Interest Rate on Personal Loan

Personal loans have become extremely simple today , particularly as the emergence of Fin tech lending startups has made the loan process much more effective, seamless and convenient with technological prowess. If you decide to take a personal loan, the most important aspect is your interest rate, as your ROI determines your borrowing cost.

There are several lenders on the market, each with loans at varying interest rates. Whereas top private banks usually offer the lowest interest rate, some P2P lenders claim to offer lower interest rates – an aspect that seems incorrect when closely looked at. Here, the two types of rate structures associated with personal loans must be understood, in particular to prevent certain lenders from hoodwinking them.

What kind of rate structures are correlated with personal loans?

The flat rate structure and the reduction rate structure ( e.g. the effective interest rate or the EIR) are the two rate structures. These two structures function differently and in a certain way each calculates interest. The issue of which of these interest rates to select is not essentially the choice of the borrower, it is the decision of the lender. But if the borrower has a choice, let’s try and see which of those rate structures work best to reduce borrowing costs.

The flat structure

The interest on your loan is calculated in the flat rate structure based on the entire principal and the annual interest rate. Let’s say you want to take a Rs. 1,00,000 loan from a lender on a flat rate of 12% p.a. For a 2-year period. The annual interest rate is allocated directly to the principal under the flat rate system. The interest you will pay is Rs. 24,000 (annual interest of 12,000 x 2 (tenure)). It looks simple and simple, isn’t it?

Reducing Interest structure

With the reduction in the equilibrium rate, interest is calculated differently – apart from your loan principal and your rate, your monthly repayments are also included. When you make repayments, the interest on the remaining balance is levied in accordance with the annual rate. In other words, interest is technically levied monthly when and when you continue to make refunds.

Let’s assume you take a Rs. 1 lakh loan under the reduction of the balance structure at a 12 percent rate. After your EMI has been determined and your first monthly refund is paid, the remaining balance of interest is calculated and levied. This continues until the whole balance is cleared.

What rate would you choose?

It is important to note that most lenders use the lower balance rate to calculate your interest. As such, lenders do not calculate interest on a flat-rate basis as the interest on this approach is significantly lower when compared with the decreasing balance rate.

Different Banks and their Interest Rate Loan Amount

Documents Required for Personal loans