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Personal loan: Things you MUST know

February 11, 2009

3. What is the difference between a fixed interest rate and floating interest rate?

A fixed interest rate remains constant throughout the loan tenure regardless of the market conditions whereas a floating interest rate can decrease or increase depending on market fluctuations. For instance, it increases when RBI hikes up short term interest rates. Banks usually quote the floating rate loans as their index rate (prime lending rate) plus or minus x per cent. Banks usually increase or decrease their prime lending rate when the RBI increases or decreases short term interest rates.

4. What are the different types of interest rates available?

Interest rates are quoted either as fixed flat rates or reducing balance rates.

In the flat rate method of interest calculation, the outstanding loan amount is never reduced during the entire tenure of the loan even though you make payments monthly.

In the case of reducing balance interest rates the EMI is calculated on the basis of daily, monthly, quarterly or annual rests.

A 'rest' indicates the time frame in which the bank will recalculate the EMI based on the amount of loan paid back and the frequency of any compounding interest rate. Suppose you have a loan with an annual 'rest' then, though you pay a monthly installment, your benefit kicks in only at year end, here the bank gets to benefit.

A monthly 'rest' will recognize the reduction in the loan amount on a monthly basis, a quarterly rest does it every quarter while a daily 'rest' will do it each day. The more closely the rest matches the frequency of your payments, the lower the total interest paid as the total outstanding loan amount is reduced by your monthly payments more frequently. <

Image: A stack of $100 bills. | Photograph: Reuters

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