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Reducing Interest Rates Pros and Cons

Reducing Interest Rates Pros and Cons

Reducing interest rates are a type of interest rate that is calculated on the outstanding loan amount and decreases as the loan balance reduces over time. This means that the borrower pays less interest every month, as they repay the principal. Reducing interest rates are also known as diminishing or effective interest rates.

How Flat Interest Rates are calculated?

Explained with an Example:-
Here is an example with a home loan of $100,000 for 15 years at a reducing interest rate of 5%:

In this case, the monthly EMI is $790.79.

• The total interest amount is calculated by multiplying the monthly EMI by the number of months in the loan tenure and subtracting the loan amount. In this case, the total interest amount is $790.79 x 180 – $100,000 = $42,342.20.

• The total amount to be repaid is the sum of the loan amount and the total interest amount. In this case, the total amount to be repaid is $100,000 + $42,342.20 = $142,342.20.

• The interest amount for each month is calculated by multiplying the outstanding loan balance by the interest rate and dividing by 12. The principal amount for each month is calculated by subtracting the interest amount from the EMI. The outstanding loan balance for each month is calculated by subtracting the principal amount from the previous loan balance.

The table below shows the monthly amortization schedule for the first year of the loan:

| Month | EMI | Interest | Principal | Outstanding Balance |
| — | — | — | — | — |
1 | 790.79 | 416.67 | 374.12 | 99,625.88 |
2 | 790.79 | 415.10 | 375.69 | 99,250.19 |
3 | 790.79 | 413.54 | 377.25 | 98,872.94 |
4 | 790.79 | 411.97 | 378.82 | 98,494.12 |
5 | 790.79 | 410.39 | 380.40 | 98,113.72 |
6 | 790.79 | 408.81 | 381.98 | 97,731.74 |
7 | 790.79 | 407.22 | 383.57 | 97,348.17 |
8 | 790.79 | 405.62 | 385.17 | 96,963.00 |
9 | 790.79 | 404.01 | 386.78 | 96,576.22 |
10 | 790.79 | 402.40 | 388.39 | 96,187.83 |
11 | 790.79 | 400.78 | 390.01 | 95,797.82 |
12 | 790.79 | 399.16 | 391.63 | 95,406.19 |

More info by making it simple:-
Here is how it works:

• Reducing interest rate is the percentage of interest that you pay on the remaining loan amount every month. For example, if you borrow $100,000 at a reducing interest rate of 5% for 15 years, you will pay $5,000 (5% of $100,000) as interest in the first month, but less interest in the following months, as you repay the principal.

• To calculate the total interest amount, you multiply the monthly EMI by the number of months in the loan tenure and subtract the loan amount. The total interest amount is the difference between the total amount to be repaid and the loan amount.

• To calculate the interest amount for each month, you multiply the outstanding loan balance by the interest rate and divide by 12. The interest amount for each month decreases as the outstanding loan balance decreases.

• To calculate the principal amount for each month, you subtract the interest amount from the EMI. The principal amount for each month increases as the interest amount decreases.

• To calculate the outstanding loan balance for each month, you subtract the principal amount from the previous loan balance. The outstanding loan balance for each month decreases as the principal amount increases.

Reducing Interest Rates Calculator:
https://www.calculator.net/loan-calculator.html

What are the Pros and cons of Reducing Interest rates?

Reducing interest rates are a type of interest rate that is calculated on the outstanding loan amount and decreases as the loan balance reduces over time. This means that the borrower pays less interest every month, as they repay the principal.

Some of the pros and cons of reducing interest rates are:

Pros of reducing interest rates:

• They are lower than flat interest rates and reflect the true cost of borrowing. The borrower pays interest only on the remaining loan amount and not on the initial loan amount.

• They are more widely accepted and offered by most lenders. They are commonly used for home loans, car loans, personal loans, and other types of loans.

• They are suitable for long-term loans or loans with large amounts. The borrower can save money and pay less interest over the loan tenure.

You may also like to know: Pros and Cons of Flat Interest Rates

Cons of reducing interest rates:

• They are more difficult to calculate and understand. The borrower may not know exactly how much interest they have to pay every month and may need to use online calculators or formulas to find out.

• They are not transparent and consistent. There may be hidden charges or fluctuations in the interest rate due to market conditions or other factors.

• They may not be available or accepted for all types of loans or borrowers. Some lenders may prefer flat interest rates or charge higher fees for reducing interest rates.

Verdict:

Reducing interest rates are a lower and more realistic way of calculating interest on loans, but they may not be the easiest or most transparent option for borrowers who want to know how much interest they have to pay. Such interest rates are calculated on the remaining loan amount and decrease over time, as the borrower repays the principal. Reducing interest rates are widely accepted and offered by most lenders and are suitable for long-term or large loans. However, reducing interest rates are difficult to calculate and understand, and may vary due to market conditions or other factors. Reducing interest rates may also not be available or accepted for all types of loans or borrowers. Therefore, borrowers should compare reducing interest rates with other types of interest rates before choosing a loan.