The Most Authentic Guide on Personal Finance and Investments

Words of Wisdom : "Be careful about reading health books. Some fine day you’ll die of a misprint." ~ Markus Herz

BEWARE!! 8% = 14.68%

I got a call from a bank offering me loan at 8% flat interest rate. Well, being a skeptical type, I naturally started looking for the hidden devils. And sure enough I found one.

What got me wondering was the fact that banks were taking deposits at 8-9%. So if they lent me at 8%, they would be incurring a loss. How would they even cover their fixed costs like salaries, rent, electricity, etc. Would a sensible looking bank deliberately make a loss? No, definitely not!!

Let's understand the gimmick employed here with an example.

Say we have a loan of Rs.2 lakhs @8% ‘flat’ interest rate, which is repayable in 2 years i.e. 24 monthly installments. [Notice the word "flat"? This is the devil].

At @8% flat interest rate, the total interest payable works out to Rs.32,000 as shown below:

    Total interest =  Loan amount * Interest Rate * No. of years
                      =  2,00,000 * 8% * 2
                      =  32,000
    Total repayment =  Loan amount + Interest
                           =  2,00,000 + 32,000
                           =  2,32,000

    No. of installments =  24 monthly payments

    Equated monthly installment =   Total payment / No. of installments
                                                =   2,32,000/24
                                                =   9,666.67 per month 

Simple? Yes.
Cheap? Well, not exactly.

So where’s the catch?

The catch is that you are paying EMI every month. A part of this amount is the interest portion and the balance is the principal portion. So month after month, as you keep paying the EMIs, your principal amount is reducing - till it finally becomes zero in the end. Technically one should pay interest only on the outstanding loan balance. But, as we have seen earlier, the interest has been calculated on flat basis i.e. on the ‘full loan amount’ for the ‘entire 2 years’.

In a ‘flat interest’ scenario you do not get the benefit of the reducing principal amount month after month. The result is that the effective interest cost to you works out to 14.68%. Yes, I repeat 14.68%.

So now it makes sense. They borrow at 8-9% and lend at 14-15%. But, we as a consumer, should beware of such so-called cheap flat interest rates.

You Learn A Lot By READING... And Even More By SHARING.

Share Button

Ignorance is like a SIGNED BLANK CHEQUE... anyone can MISUSE it.

Subscribe via Email
Books by Sanjay Matai
[Click on the Pic for more info on my books.]
Powered by Blogger.

Inflation, Interest Rate and Raghuram Rajan's Dosa Economics

Interest rates are always a source of conflict. Borrowers demand low rates. Fixed Depositors desire high rates. In such a scenario, what ...

Total Pageviews