Comparing Two-Wheeler Loan Interest Calculation Methods
Loans by Team Drivio | 9th Dec 23
Understanding different interest calculation methods for loans can help you compare motorcycle loans and settle for the one offering cost-effectiveness and convenience. This method significantly impacts the cost of your loan.
While most of us hunt for affordable motorcycle loans, do you really compare how banks and NBFCs calculate your EMIs? Comparing two-wheeler loan interest calculation methods is a crucial process before you finalize your lenders. With the demand for two-wheelers shooting up in India, most owners turn to lenders for financing their purchases.
The method used in calculating the interest on your two-wheeler loan largely determines your overall cost of borrowing. Understanding different interest calculation methods for loans will help you narrow down the most lucrative deals from reputed lenders.
While you might consider fixed and variable rate interests, it’s easy to overlook other methods of interest calculation like reducing interest rate loans. These overlooked aspects can increase your overall cost of borrowing.
In this guide, we have explained the different approaches to calculate the interest on two-wheeler loans.
Fixed Interest Rates on Two-Wheeler Loans
Under a fixed-interest rate loan tenure, borrowers lock the interest at the current market rate. This implies that you already know the rate of interest throughout the duration of the repayment, which makes your EMIs predictable. At the beginning of the loan tenure, the lender will provide you with a specific repayment schedule, where the EMI will remain the same across all the months.
It’s advisable to settle for a two-wheeler loan at a fixed-rate interest when the market prices remain low. So, even if the rates increase after a few months, your EMI won’t be affected. This is a strategic move to keep your loan affordable.
Pros of fixed interest rate loans
- Borrowers enjoy peace of mind when monthly repayments remain consistent.
- You can simplify your financial planning with fixed-rate interest and allocate funds to other heads.
Cons of fixed interest rate loans
- Some banks may charge higher rates if you try to lock it at the current market price.
- In a falling market, you can miss out on the opportunity to save money once you lock into the deal.
Floating Interest Rates on Two-Wheeler Loans
Floating interest rates closely follow the market changes and are responsive to the ongoing trends. When you finance your two-wheeler with a loan that involves a floating rate of interest, your EMIs can fluctuate during the tenure. While this presents you with the opportunity to save on the interest paid, you may also end up paying higher interest if the rate shoots up later.
Since your EMI remains unpredictable, you need to leave a considerable margin for flexibility on both ends.
Pros of floating interest rate loans
- You may benefit from lower interest rates during periods of market decline. This will reduce your overall cost of repayment.
- Borrowers can capitalize on favorable economic conditions.
Cons of floating interest rate loans
- The variable nature of floating rate interest brings in the factor of uncertainty. Thus, borrowers find it challenging to predict their monthly financial outflows.
- In rising markets, settling for a floating rate interest loan can lead to higher monthly repayments.
Flat Interest Rate vs Reducing Balance Interest Rate
Flat Interest Rate Method
This is a straightforward approach where banks calculate the interest on the entire principal throughout the loan tenure. Thus, the interest will remain the same over the loan duration, and you need to pay equal instalments.
Although this method offers predictability, borrowers face a drawback. Compared to other methods, they end up paying more interest.
Reducing Balance Interest Rate Method
The reducing balance interest rate involves a more sophisticated approach where the interest is calculated on your decreasing outstanding loan balance after you pay each EMI. The bank needs to recalculate the interest based on the remaining principal amount each month. Over the loan tenure, you need to pay less on interest, thereby making a substantial saving.
Flat Interest Rate vs Reducing Balance Interest Rate
Now that you know that the reducing balance interest rate approach proves to be more cost-effective, let’s compare flat and reducing balance interest rates under a few other parameters.
Stability in payments
With the flat interest rate, your instalments remain the same throughout the tenure. This can prove to be advantageous for budgeting purposes. However, choosing the reducing balance interest rate method means you need to shell out variable amounts each month. While you end up saving on your interest, some borrowers may prefer the stability offered by the flat interest rate method for consistent budgeting.
The reducing balance interest rate method encourages financial discipline as it encourages you to pay off the principal faster. As you progress through the tenure of the loan, a significant portion of each instalment is used to repay the principal amount first. This fosters a sense of financial responsibility, which serves as a motivating factor for individuals willing to repay their loans efficiently.
The reducing balance interest rate offers greater transparency. You can explicitly check how much interest you are paying on the principal with each EMI. Besides, you can easily track your progress and understand what part of each Emi contributes to reducing your debt.
While comparing two-wheeler loan interest calculation methods, consider your repayment capacity and rates of interest. Now that you understand how lenders calculate interest rates, be prudent enough to settle for a low-cost loan.
Financing your motorcycle through a bank loan may be apparently easy. However, a proactive approach from your end can help you save significantly on interest over time.