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| Personal loan isn’t that cheap
Personal loan interest rates are not what they look. The question to be asked is what period is the lender charging the interest for. Question whether the interest is being charged is 2% monthly, 2% half yearly or 2% yearly. An interest of 2%, which compounds monthly, works out to a yearly rate of almost 27%.
Corporation Bank cuts home, vehicle loan rates
The most important question to ask is how is the interest is being calculated. Take the case of a bank offering a personal loan of Rs 50,000 at an interest of 12% p.a. to be repaid over a period of 36 months. The EMI to repay the loan works out to Rs 1,890 p.m. The question is how a bank can offer a loan at an interest rate of 12% per year, when the interest rate of home loans is similar.
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The bank’s logic is – an EMI of Rs 1,890 p.m. means that for 3 years you will pay the bank Rs 68,040 (Rs 1,890 x 36). Of this the principal amount i.e. the loan you have taken is Rs 50,000. What remains is the interest. So an interest of Rs 18,040 (Rs 68,040 - Rs 50,000) will be paid over a period of 3 years.
The interest paid per year amounts to Rs 6,013 (Rs 18,040/3). An interest of Rs 6,013 p.a. on a loan amount of Rs 50,000 means an interest rate of around 12%. This way of expressing interest is known as the flat rate of interest. This is not the correct way to calculate.
The actual interest should be 21.25%, which is 9% higher than what the bank makes it out to be.
Every time an EMI is paid, a certain part of the principal amount i.e. the actual loan that you had taken is repaid. Hence, the interest at any point of time has to be calculated on the loan outstanding.
This is the correct way of calculating interest and is known as the reducing balance method.
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