When it comes to securing a business loan, one of the most pivotal factors to evaluate is the interest rate. For entrepreneurs, business loan interest rates are often the linchpin influencing their choice of lender and the ultimate decision to proceed with a loan application. These interest rates play a pivotal role in shaping the equated monthly installments (EMIs), which become a mandatory financial commitment for your enterprise. Therefore, it is essential for business owners to gain a deep understanding of the applicable interest rates, their calculation methodologies, and the significant distinctions between flat interest rates and reducing rate of interest before embarking on the loan application journey.
For Micro, Small, and Medium-sized Enterprises (MSMEs), the decision between opting for a flat or reducing rate of interest is particularly critical due to their inherently delicate financial ecosystems. MSMEs often operate on slender profit margins and have limited financial resources. Therefore, the choice of interest rate structure significantly impacts their cash flow, sustainability, and ability to seize growth opportunities. Opting for the right interest rate structure can mean the difference between manageable EMIs that support steady operations and excessive financial strain that could hinder their growth prospects. Let’s explore how flat vs. reducing rate of interest works out for businesses.
Flat interest rates are a specific type of interest calculation that maintains a constant rate throughout the entire loan tenure. This means that the interest rate remains unchanged, even if the principal loan amount gradually diminishes over time. Typically, flat interest rates structures find application in loans such as car loans, mortgages, and other financial arrangements where borrowers commit to repaying the loan within a stipulated time frame.
Consider this scenario to understand how flat interest rates work: An MSME entrepreneur secures a loan of Rs. 100,000 with a flat interest rate of 10%. In this case, the annual interest amounts to Rs. 10,000. Consequently, the entrepreneur must make monthly payments comprising both principal and interest components. These monthly payments will start with relatively higher amounts in the initial years of the loan when the principal balance remains substantial. As time progresses and the principal amount decreases, the monthly payments gradually decrease as well.
While flat interest rates are relatively easier to comprehend and calculate, they tend to be more expensive compared to the reducing rate of interest. Despite their higher cost, flat interest rates may appeal to borrowers seeking predictability in their monthly obligations.
Reducing Rate of Interest, on the other hand, employs a method of interest calculation wherein the interest rate applied to the outstanding loan balance decreases as the loan matures. In this scenario, borrowers pay progressively less interest over the life of the loan as the interest component in each payment gradually diminishes.
Consider this example: If an MSME entrepreneur secures a loan with a reducing rate of interest of 6% and an initial principal balance of Rs. 1,00,000, the first monthly payment allocates Rs. 1,50 towards the principal and Rs. 1,00 towards interest. In the subsequent month, with a reduced principal balance of Rs. 98,500, the interest component decreases to Rs. 98.50. This pattern continues until the loan is completely repaid.
For borrowers seeking to make informed decisions, calculating EMIs for both flat interest rates and the reducing rate of interest can be empowering. Here's how to do it:
Interest on every installment = (Total loan amount * loan tenure * yearly interest rate) / total installments. For example, for a loan of Rs 2,00,000 with a fixed interest rate of 10% per annum for a 4-year tenure, the interest amounts to Rs 80,000 (2,00,000 * 4 * 10/100), resulting in a total repayment of Rs 2,80,000.
Interest on every installment = outstanding loan amount * interest rate applied on every installment. For a loan of Rs 1 lakh at a variable interest rate of 10% per annum for a 5-year tenure, the reducing rate of interest results in progressively lower yearly payments as the outstanding balance reduces with each installment.
Ultimately, the choice between flat interest rates and the reducing rate of interest hinges on individual circumstances and financial objectives. MSMEs contemplating a loan must diligently compare different interest rates and terms to identify the most suitable option for their business. Notably, various Non-Banking Financial Companies (NBFCs), including Kinara Capital, offer collateral-free business loans with reducing rate of interest Kinara Capital extends its support to entrepreneurs with offerings such as working capital loans, asset purchase financing, and specialized loans designed for women entrepreneurs, including the Her Vikas program.
For those seeking guidance or assistance, Kinara Capital provides multilingual doorstep customer services, accessible via a missed call at 080-68264454, where MSME entrepreneurs can directly engage with Kinara's in-house customer support team and get the help they need to make informed choices about business loan interest rates.
