Buying a car is a dream come true for people of all ages, whether they are salaried or self-employed. Most banks today offer various perks to customers for financing car loans such as paperless process, no documentation, instant loan disbursement, 100% on-road finance, flexible repayment terms ranging from 12 months to 84 months, And so on. But, the most important factors that borrowers do not inquire from the bank are the hidden charges and whether the interest rate applicable is fixed or reducing.
Flat interest rates are effectively higher than compounding interest rates, and interest rates remain constant throughout the term of the loan, determined based on the principal amount of your car loan. Under the reducing balance rate method, the interest rate is determined on the outstanding loan amount on a monthly basis only. So when it comes to flat vs declining interest rates, which one should borrowers choose for their car loan, let us hear from the experts.
S Ravi, former chairman of the Bombay Stock Exchange (BSE)
When taking out a car loan, the lender may offer either a fixed or a low (also known as a variable) interest rate.
A fixed interest rate remains the same throughout the term of the loan. This means that your monthly payment will remain the same and you will know exactly how much you will be paying over the life of the loan. Fixed interest rates are often preferred for their stability and predictability, making it easier for borrowers to budget and plan for payments.
A low interest rate or low interest rate, on the other hand, can fluctuate over the course of the loan. This means that your monthly payment can go up or down depending on the interest rate change. Reduced interest rates are often lower initially but can add up over time, resulting in higher payments.
There are advantages and disadvantages to both fixed and compound interest rates; The best option will depend on your specific financial situation, preferences and repayment capacity.
Fixed interest rate example: If you take a loan of 1 lakh with a flat interest rate of 10% per annum, let’s say for 5 years, you will end up paying Rs. 20000 (Principal Repayment @ 1 Lakh/5) + Rs. 10,000 (interest @ 10%) which is equal to Rs. 30,000 per annum or Rs. 2500 per month.
Example of Decreasing Interest Rate: If your loan is 1 lakh for 5 years at 10% per annum, your EMI will reduce with every repayment. In the first year, you will pay Rs. 10,000 as interest, in the second year you get Rs. Will pay 8000 as interest on the reduced principal of Rs. 80,000 and so on till the last year where you will pay Rs. 2000 as interest. In this method, the interest rate is calculated only on the outstanding loan amount on a monthly basis.
Nehal Gupta, Director, AMU Leasing
It is important to understand the difference between fixed and decreasing interest rates before taking a car loan. A fixed interest rate remains constant throughout the loan tenure, while a compounding interest rate decreases with each installment payment. Knowing the difference can save you money and help you make informed financial decisions.”
For example, assume you take a car loan of Rs 1,00,000 with a fixed interest rate of 5% per annum for three years. In this case, you will pay a flat interest rate of 5% per annum on the initial loan amount of Rs.1,00,000 throughout the loan tenure, resulting in a fixed EMI (Equated Monthly Installment) amount.
On the other hand, if you take a car loan of ₹1,00,000 with a decreasing interest rate of 5% per annum for three years, the interest rate will be calculated on the outstanding amount each month. Hence, as you pay each installment, the outstanding loan amount comes down, and so does the interest. This results in a variable EMI amount, which reduces over time as you repay the loan.
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