With interest rates heading southward, it is prudent to check whether you are paying the right interest rate on your loans. For this, you need to check the terms and conditions contained in your loan agreement and find out whether your bank is complying with those terms and conditions. Here is what you should look at in your loan agreement:
Floating Rate or Fixed Rate:
Check whether your loan is a fixed or floating rate loan. If it is a fixed rate loan, the rate of interest will remain irrespective of changes in market rates (subject to certain conditions, of course!). However, if you have taken the loan on floating interest rate basis, then every downward or upward movement in interest rates would be reflected in corresponding upward or downward revision of your rate of interest. Banks are quite prompt when it comes to revising their interest rates upward if interest rates go up, but check out whether your bank is giving you the benefit of downward revision of interest rate too. If you are getting the benefit, good for you, but if your bank is lethargic or reluctant on revising your interest rate downward, you better remind them about the lower interest rates of other banks and financial institutions.
Flat Rate or Reducing Balance Rate:
The flat rate of interest is charged on the initial loan amount taken by the borrower, so the interest amount charged remains constant over the tenure of loan. The flat rate may be less than the reducing balance rate, but the interest outgo may be higher if the tenure of loan in long. The reducing balance rate is charged on the balance outstanding at the end of every month or every year, depending on the rest period. The reducing balance rate may be higher than the flat rate, but over the long term it may work out cheaper, depending on the difference between the two rates of interest and the rest period. Nowadays, banks and financial institutions usually give loans based on the reducing balance method.
The rest period of a loan is the periodicity of recalculating the balance outstanding of your loan amount by deducting the principal amount repaid by you from the loan amount. The rest period comes into play in the case of reducing balance method and this period can be daily, monthly, quarterly, half-yearly or yearly. The lower the rest period, the more the advantage for the borrower as the interest outgo reduces every time the borrower pays the EMI. So, if your loan is on a daily reducing balance method, nothing like it, because you would be saving on your interest outgo every time you pay the EMI or prepay the loan amount.