Sometimes it becomes very difficult for the customers to understand the interest charged on the loan as to how the bank is charging interest on the loan amount. Today in this article we will understand the reducing balance method used by most of the banks to recover interest on home loan, personal loan, auto and gold loan.
What is reducing balance method?
Under reducing balance, interest is charged on your remaining principal amount after payment of each installment. Its biggest advantage is that as you keep repaying the loan, your loan amount reduces and hence you have to pay less interest.
Example: If you have taken a loan of Rs 10 lakh and you pay EMI of Rs 10,000 per month on it and with month to month installment payment, your loan will be reduced and you will have to pay less interest.
Benefits of reducing balance
- low interest: Its biggest advantage is that as the principal amount reduces with the loan repayment, you have to pay less interest in the long run.
- Payment on time: In this, interest is calculated on the basis of the principal amount. In such a situation, the person taking the loan is also encouraged to pay the installments on time.
- transparent: In reducing balance, as installment payments are made, the principal amount gets reduced and less interest has to be paid. For this reason reducing balance is considered one of the transparent methods of loan.
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