A personal loan can help you achieve a variety of goals and ambitions in your life. These loans can be utilised for a range of things, like financing your ideal wedding or a foreign trip, buying a consumer durable, or consolidating credit card debt. There are no limitations on how you can put the money to use. Because this is an unsecured loan, you are not required to provide any collateral, your bank imposes unique fees and charges.

Getting a loan using a personal loan app is really convenient nowadays. You can get a loan from any of the numerous internet lenders that have evolved in India over the last few years. However, you must carefully read the fine print. Factors such as payback term, interest rate, and other fees might raise your borrowing costs and EMIs.

What a personal loan entails in terms of your finance

Doing your homework before making a large purchase or getting into a financial transaction is a great idea. The more you know about borrowing costs before you borrow, the better off you will be in the long run.

Applying for a loan has never been easier thanks to loan apps. The tough part is reading the terms and conditions and fine print that come with them. To understand how total interest is computed, you must first comprehend terms like annual percentage rate (APR) and different types of interest rates.

What is APR?

APR, or Annual Percentage Rate, is a phrase used frequently in the banking industry. Despite its widespread use, this word may cause misunderstanding among first-time loan borrowers. This is a different interest rate than the conventional rate of interest, which is why, before taking out a personal loan, an applicant should be well-versed in APR. Only by understanding the many forms of interest rates that you must pay annually will you be able to reap the full benefits of taking out a loan.

The annual percentage rate (APR) on your loan might help you figure out how much your loan will cost you over time. It is stated as a percentage and shows the annual cost of a loan.

The interest rate and finance fee associated with a loan and its repayments are referred to as the APR or Annual Percentage Rate. The APR is determined by a variety of criteria, including the amount of the loan, the length of the payback period, and your credit history.

The nominal interest rate and additional fees connected with obtaining and servicing a loan are factored into the annual percentage rate. Administrative expenditures, insurance costs, processing fees, and other expenses are included in the fees. However, when determining the actual borrowing cost of a loan, an APR ignores the compounding bit.

Importance of APR

APR provides its own set of benefits above a loan’s normal interest rate. Here are the advantages of APR against the basic interest rate.

APR is a common calculation technique that gives borrowers an exact statistic that they can use to compare interest rates offered by various lenders and select the cheapest and most competitive loan on the market. Without compounding, the APR comprises all fees and charges associated with the financial product.

Interest rates, fee structures, charges, penalties, waivers, and other aspects of loans and other financial products differ from one organization to the next. Because APR is a standard rate, it is easier for borrowers to understand how much they will have to pay back on their loan and which lender is the best option.

Because APR includes all fees and costs, not just interest rates, it aids customers in better understanding the true cost of a loan. This tool allows you to see the actual sum right in front of your eyes, making it easier to assess your ability to repay the loan before you take it out.

APR calculator

An APR calculator is a tool that allows you to figure out how much you’ll have to pay each year for your loan. Simply enter the interest rate, processing charge, and other loan-related details. The tool will automatically calculate how much you must pay by the end of the year.

Affect of APR on interest

It’s critical to understand APR in order to ensure that you can afford the payments. Taking into account the loan type will help you save money on interest.

You have the option of taking out a secured or unsecured loan. The type of loan you select has an impact on your payback schedule. Let’s look at secured and unsecured personal loans first to see how APR influences your interest rate.

Secured loans

Secured loans require you to put up collateral to secure the loan amount. While securing collateral is difficult, the APR on a secured personal loan is rather modest. As a result, a secured loan makes repayments easier.

Unsecured loans

You do not need to put up any collateral to secure an unsecured loan. Your APR and repayments will be higher if you choose an unsecured borrowing option like a personal loan.

Flat and Reducing Interest Rate

When taking out personal loans, you must be cautious about the type of interest rate you are charged. One of two approaches is used to compute the personal loan interest rate:

Flat interest rate

The interest is calculated on the full loan amount, which is the principal, with a flat interest rate. For the purposes of calculating monthly interest, only the principal amount is taken into account. The total interest on your loan is computed first, and then it is added to the principle. The total is then divided evenly throughout your repayment period. When you use the flat interest rate option, your monthly EMI stays the same. When you utilize this strategy, it doesn’t matter if you’re paying your first or second-to-last EMI; all of your EMIs will be the same.

Reducing interest rate

The reducing interest rate approach, as the name says, reduces your interest rate each month. The interest rate is determined by the outstanding principal amount, which decreases month after month.

Method of interest calculation

You should use the reducing interest rate approach to calculate your interest. Your monthly interest outflow will be reduced if you choose this strategy. The amount you could save using this strategy is determined by the loan’s principal, interest rate, and terms. The amount of money you’d save by choosing the reducing interest technique instead of the flat rate option isn’t always significant. However, before accepting any personal loan offer, make sure you understand your loan terms and the process used to calculate interest. 

When you pay your monthly EMIs using this method, a portion of the money goes toward interest and the balance goes toward paying off your principal. As a result, your principal balance decreases month after month. So the amount of interest computed on the principal lowers. As a result, with each EMI, your interest amount decreases.

Conclusion

You must understand that the cost of your personal loan is determined by a variety of criteria, including the loan type, payback term, loan amount, creditworthiness, and so on. Among all of these elements, the interest calculation method or APR may not be of much use. You must ensure that you have sufficient repayment ability in order to repay the loan.