MYTH-13. ALWAYS TAKE A BANK LOAN WITH THE LOWEST INTEREST RATE
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When you take a bank loan, make sure you understand how the interest rate on the loan is calculated.
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A flat rate of
interest may appear low but works out to be costlier than a normal loan.
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The flat rate is
arrived at by dividing the total interest paid on the loan by the number of
years, and appears lower than the interest rate calculated on a reducing
balance basis.
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But you are being
charged for the entire loan amount even though the outstanding amount reduces
progressively with every equated monthly instalment (EMI) paid.
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Therefore, a flat
rate of 10% is a lot more expensive than a normal reducing rate of 12%, as its
actual cost becomes around 19.46% in a 3-year duration loan.
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Similarly,
advance EMIs push up the effective interest cost for the borrower, because the
actual loan disbursed is reduced by the amount of these advance payments even
though the borrower is charged interest for the full amount.
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Some banks also
insist on the borrower parking some money in a fixed deposit with them, which
also pushes up the effective interest on the borrowing as the rate of interest
offered on these deposits is not very attractive.
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Borrowers should
also avoid getting carried away by special offers, as these do not bring down
the base rate to which all loans are linked, but just reduce the spread
between the base rate and the rate charged to the customer.
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It is best to
stick to the normal reducing balance calculation when comparing interest rates
of various lenders, by asking them to quote the EMI for a fixed amount to normalize
all quotations.