Flat Vs Reducing Rate of Interest – Which Option is Best for Your Business?

When it comes to applying for a business loan, one of the most critical factors that you must consider is the interest rate levied by the lender. For business owners, the interest rate on the business loan is the influencing factor in their choice of lender. It also has a direct impact on the EMI (equated monthly instalments), which becomes a mandatory financial commitment for your business. Hence, as a business owner looking to avail of a loan, you must have a good understanding of the applicable interest rates, the calculation methodology and the difference between flat and reducing interest rates before you initiate the application process.

 

If you are an SME (small and medium enterprise) owner, the decision between choosing a flat or reducing interest is even more critical because of the delicate financial ecosystem of your business. Generally, the SMEs have limited financial resources. And, if your business too is operating on a slender profit margin, your choice of interest rate structure could make a huge difference to the cash flow in the business, the ability to capitalise on the new business opportunity, and keep the business operations running smoothly for long.

 

If you are a first-time business loan borrower and are unsure which interest rate to choose, this flat vs. reducing interest rate comparison guide is for you.

 

What is a flat interest rate?

 

In a flat-interest rate business loan, the lenders calculate the interest on the full principal amount, which remains fixed throughout the loan tenure. This means that even as you repay the EMIs over time, your principal amount may gradually reduce, but you still continue to pay the interest on the actual amount you borrow.

 

Generally, the flat interest rate is applied to car loans, mortgage loans, etc., where the borrower agrees to repay the loan within a specific time frame. The formula for calculating the flat interest rate is as follows:

 

Interest due in each instalment = (original loan amount x loan tenure x annual interest rate) / number of instalments

 

Let us understand the interest calculation better with an example.

 

Let us assume you have availed a business loan of Rs. 2 Lakh with a fixed interest rate of 10% per annum for a period of 4 years. Then, as per the formula, your total interest repayment calculation would be –

 

80,000 (2,00,000 x 4 x 10/100) = 2,80,000

 

So, for a loan of Rs. 2 Lakhs, your total repayment would amount to Rs. 2, 80,000

 

 

 

 

Pros and cons of flat interest rate

 

• In flat-interest rate business loans, the EMIs remain unchanged throughout the loan tenure. This allows you to better plan your finances and not worry about fluctuations.

   

• The EMI calculations in flat-rate loans are fairly simple. You can use the online EMI calculator to know the exact EMI you must pay with just a click of a few buttons.

   

• Flat-rate business loans are particularly beneficial for farms, which may rely on them to meet their immediate fund requirements. The simplicity of the flat-rate calculations makes it easier for them to comprehend and manage the payments.

   

• One drawback of the flat interest rate business loan is that you may pay more interest over time as the interest is calculated on the entire principal amount.

 

What is reducing interest rates?

 

As the name suggests, the reducing rate of interest or diminishing balance rate of interest is calculated based on the outstanding amount. When you pay the EMI every month, with each payment, the outstanding loan amount decreases, resulting in lower interest payable with the subsequent EMI payments.

 

You can calculate the interest payable per instalment under the reducing rate of interest, you can use the following formula:

 

Interest due per instalment = interest rate per instalment x balance loan amount

 

 

 

Pros and cons of reducing interest rate

 

Now that you know the meaning of reducing the rate of interest, it would help to know its advantages and drawbacks.

 

• One of the most significant benefits of reducing interest rates is that you pay less interest over time compared to flat-rate interest loans. This can significantly reduce your business's overall borrowing cost.

   

• Since the monthly interest payments reduce gradually with every instalment, you can afford to repay the loan faster and be debt-free.

   

• The reduced interest rate business loans give you more flexibility in terms of repayment tenure. You can choose a loan tenure to suit your business’ financial capacity.

   

• While there are many benefits to opting for a reducing interest rate business loan, one drawback is that the interest rate for such loans tends to be a little higher than that of fixed-interest rate loans.

 

 

Flat rate or reducing rate of interest – which is best for your business?

 

It is evident from the flat rate vs. reducing rate comparison that both these interest types have their share of pros and cons, and there is no clear winner here. So, the choice between choosing a flat interest rate and reducing interest rate business loans boils down to your business objectives and circumstances.

 

As an SME owner, when you are looking to avail of a business loan, you must diligently compare the interest rates and terms and conditions offered by different lenders to make the right choice. Notably, many NBFCs (non-banking financial companies) like Udyog Plus offer unsecured business loans at competitive interest to help businesses get the desired working capital, buy new assets, etc. You can get a loan of up to Rs. 2 Lakh without any documents.

 

Also, the simple online application process in just four steps and same-day approval and disbursements let you get access to funds faster and enjoy a hassle-free borrowing experience. So, visit the Udyog Plus website to know more about the different business loan solutions apply for the loan online, and take your first step towards taking your business to the next level. Apply Now!