i wanted to know I am taking 2 wheeler loan and loan amount is 275000 for 5 years. The bank has offered me 8.5% flat interest rate & 16% reducing rate which one should i prefer taking into consideration of prepayment

Ans: It is good that you are comparing the loan options before signing the agreement. Most borrowers only look at the EMI and miss the actual cost of borrowing.

» Understanding Flat Rate Vs Reducing Rate

– In a flat-rate loan, interest is calculated on the original loan amount throughout the tenure.

– In a reducing-balance loan, interest is charged only on the outstanding balance.

– As your principal reduces every month, the interest amount also reduces.

– Therefore, comparing 8.5% flat with 16% reducing only by looking at the percentage can be misleading.

» If You Plan To Prepay

– The reducing-balance method is generally more favourable.

– Every prepayment directly reduces the outstanding principal.

– Future interest is then calculated on the lower balance.

– This means you get a real benefit from prepayment.

– In a flat-rate structure, the benefit of prepayment is often lower because the interest calculation is based on the original loan amount.

» What You Must Check Before Deciding

– Is there any prepayment penalty?

– Is part-prepayment allowed?

– After prepayment, will EMI reduce or tenure reduce?

– Are there any processing fees or hidden charges?

– What is the total repayment amount under both options?

Sometimes a lower-looking interest rate can result in a higher total cost because of the way the loan is structured.

» My View As A Certified Financial Planner

– If you are reasonably sure that you will prepay the loan within a few years, the reducing-balance option generally deserves preference.

– It rewards early repayment.

– It provides greater flexibility.

– It usually reflects the true outstanding liability more fairly.

» One More Thought

– A two-wheeler is a depreciating asset.

– Therefore, if your cash flow permits, try to close the loan faster than the original tenure.

– Reducing debt early on depreciating assets improves your overall financial health.

» Finally

– Based purely on the information provided and considering your intention to prepay, I would lean towards the reducing-balance option rather than the flat-rate option.

– However, before signing, ask the bank for the total repayment schedule and prepayment rules of both options.

– The best choice is the one with the lower total borrowing cost and greater flexibility for early closure.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in

https://www.linkedin.com/in/ramalingamcfp/