If you have ever applied for a bank loan, then you know that there are quite a number of different types available. All of them have their advantages, disadvantages, and application process. While the loans might fundamentally differ from one another, one thing is constant in all of them; they all have interest rates attached. Interest rates are the main reason banks offer loans in the first place; it is how they make their money.
Before you apply for a particular loan, it is important to know the particulars. What you need to know is that the loans officer you deal with will most probably only showcase the glossy side of taking up the loan. They won’t necessarily highlight just how much more you will have paid back once the loan term comes to an end.
Just as different banks offer different types of loans (home loans, car loans, business loans, personal loans, etc.), they also have different types of interest rates charged on those loans. For the most part, you will find that the bank charges you either a “Flat Interest Rate” or a “Reducing Interest Rate.” There is a huge difference between the two and whichever one you choose will have a considerable impact on how much you end up paying.
You calculate a flat interest rate on the full amount of the original loan without taking into account that the principal loan, as well as the interest charged, reduces with time. If you go in for a loan of $1,200 today and get a flat interest rate, you will know exactly how much you will owe for the entire tenure of the loan.
If that $1,200 loan had a flat interest rate of 5% attached to it for 12 months, you would then be required to pay:
At the end of it all, you will have paid the bank the $1,200 you owe them plus an additional $60 on account of the flat interest rate. This is all the information you get as soon as you apply for the loan.
The flat interest rate model has some distinct advantages and disadvantages. Let’s start with the advantages:
With a fixed interest rate, you can simply come up with a total figure that you are comfortable paying per month and calculate backward to find the ideal loan amount before walking into the bank. If you find that the ideal loan amount isn’t the figure you need, then you can get a full picture of how much you will need to pay per month for the full value and work with that information to ensure that you have that money ready every month to repay your loan.
You will also know how much tax benefits you will get by deducting the loan’s interest. This figure is much more difficult to pinpoint when using other interest calculation methods such as variable interest rates. Of course, the other advantage is that flat interest rates are much simpler to understand and calculate. You will not feel as if there is something the lender is hiding in the fine print.
While transparency is the biggest advantage a flat interest rate loan offers, there are still some disadvantages that come with this form of borrowing. The biggest disadvantage is that a business loan with a flat interest rate attached can end up being more expensive over time. Take for example the following two examples:
Loan A: Fixed Interest Rate
Loan B: Variable Interest Rate
In this example, the second loan is much cheaper than the first one with a fixed interest rate. Now, bear in mind that this scenario assumes the variable interest rate remains low and does not fluctuate into a higher figure over the 10-year period (not very likely to happen). Should that be the case, then the second loan will be much cheaper.
The only problem with variable interest rates is that they fluctuate, and you never really know how much you may be liable to pay by the end of the loan term.
As a business owner who does not want any financial surprises in the future, taking a loan with a fixed interest rate is perhaps the best course of action for you.
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