Know about interest rate being charged on personal loan

Most of us take personal loans but do not pay attention on interest rates being charged. There are some points regarding the interest rates such as what is period the lender charging the interest for and how the interest is being calculated?

The first question for what period is the lender charging the interest? Whether the interest is being charged is 2% monthly, 2% half yearly or 2% yearly. An interest of 2%, is compounded monthly works out to a yearly rate of almost 27%.

Then how the interest is being calculated? For instance a bank is offering a personal loan of Rs 50,000 at an interest of 12% p.a which is to be repaid over a period of 36 months. Therefore the EMI to repay the loan works out to Rs 1,890 p.m. Here the question arises how a bank can offer a loan at an interest rate of 12% per year, when the interest rate of home loans is similar.

The bank’s calculated EMI in the following manner — an EMI of Rs 1,890 p.m. means that for 3 years you will have to pay the bank Rs 68,040 (Rs 1,890 x 36). Of this the principal amount i.e. the loan you have taken is Rs 50,000. What remains is the interest. So an interest of Rs 18,040 (Rs 68,040 - Rs 50,000) will be paid over a period of 3 years.

Therefore the interest paid per year totals to Rs 6,013 (Rs 18,040/3). Thus an interest of Rs 6,013 p.a. on a loan amount of Rs 50,000 means an interest rate of around 12%. This way of expressing interest is known as the flat rate of interest. But this is not the correct way to calculate.

The actual interest should be 21.25%, which is 9% higher than what the bank makes it out to be.

Thus every time an when you pay EMI a certain part of the principal amount i.e. the actual loan that you had taken is repaid. Therefore, the interest at any point of time has to be calculated on the outstanding loan.

Thus this is the correct way of calculating interest and is known as the reducing balance method.

Interest rates on home, car and other personal loans set to fall

High spending consumers can now start planning for taking loans for various reasons as public sector banks and private banks too are going to reduce interest rates on loans therefore home, car and other personal loans are going to get cheaper.

Soon after the meeting with finance minister Mr P Chidambaram, public sector banks led by State Bank of India gave strong signals of cutting interest rates for home and car loans by at least 50 basis points. Earlier country’s largest lender, SBI, had promised to review its lending rates later this week.

In the meeting with Mr Chidambaram, the heads of public sector banks had discussed ways and means to protect the growth momentum from possible adverse effects of the current global financial meltdown.

After the attending the meeting, the heads of banks including UCO Bank and IDBI Bank announced reduction in benchmark Prime Lending Rates (PLR) by 50 basis points. Before the meeting SBI chairman Mr OP Bhatt had said, “Interest rate cut is on our agenda”.

Other banks who have announced reduction in PLR by 50 basis points include the country’s third largest lender, Punjab National Bank, and UCO Bank, IDBI Bank and Union Bank of India.

Interest rates on all loans given by a bank, fixed or floating are linked to the benchmark rate therefore cut down in PLR is of very important. Increase and decrease in interest rates on car, home or personal loans depend on the increase or decrease in PLR.

PNB was the first bank to announce a cut in lending rates and the Union Bank of India announced cut yesterday. Bank of India has also indicated that it would be deciding upon revising of interest rates very soon.

While the largest private sector lender, ICICI Bank, sources said it will be reviewing the lending rates after watching the impact of the liquidity injection steps taken by RBI last week. On Saturday RBI had cut the short-term lending rate by 50 basis points and the cash reserve ratio by 100 basis points.

The meeting was held between the FM and the chiefs of the banks after the Prime Minister and the industry leaders had met to seek appropriate measures to enhance liquidity and other steps to create an environment conducive for lowering of interest rates.