How the Monthly Reducing Balance Method Affects Your Loan Interest

Introduction

The monthly reducing balance method is a widely used approach for calculating interest on loans in India. It ensures that interest is charged only on the outstanding principal after each EMI payment. This method is particularly relevant for Home Loan and Business Loan solutions as it offers transparency and fairness in repayment. Borrowers benefit from reduced interest over time, making it a preferred choice for long-term commitments. In this guide, we will explore its definition, working, benefits and comparison with other methods.

What is the Monthly Reducing Balance Method?

The monthly reducing balance method calculates interest on the remaining principal after each EMI payment. Unlike flat rate methods where interest is computed on the entire principal throughout the tenure, this approach reduces the interest burden as the principal decreases. It is commonly applied to secured loans such as Home Loan and Business Loan solutions, ensuring borrowers pay interest only on what they owe. This method significantly impacts on total interest paid, making it cost-effective for long-term financing.

Also Read: What is Business Loan: Complete Guide

How the Monthly Reducing Balance Method Works: An Example

Consider a Home Loan of ₹10,00,000 at an interest rate of 8% for a tenure of 10 years. Under the reducing monthly balance method, the EMI remains constant throughout the loan tenure. However, interest is calculated each month on the outstanding principal, which gradually reduces with every repayment. As a result, the interest component is higher in the initial EMIs and decreases over time, while the principal repayment increases correspondingly.

The same principle applies to Business Loan solutions, enabling borrowers to pay interest only on the remaining loan balance. This structure helps businesses manage cash flows efficiently while reducing the overall interest burden over the loan tenure.

Monthly Reducing Balance vs Other Interest Calculation Methods

Flat rate methods calculate interest in the entire principal, leading to higher costs. Daily reducing balance recalculates interest daily, offering even more savings but requiring complex tracking. Monthly reducing balance strikes a balance between simplicity and cost-effectiveness. For borrowers seeking clarity and affordability this method is ideal. It ensures predictable EMIs and lower total interest compared to flat rate systems.

Also Read: What is EMI? Full form, Meaning, Calculation and How it Works

Benefits of a Monthly Reducing Balance Loan

Loans using the monthly reducing balance method offer borrowers a fair and cost-effective repayment structure. By recalculating interest on the outstanding principal, this approach ensures transparency, predictable EMIs and significant savings over time. It is ideal for long-term commitments such as Home Loans and Business Loans.

• Lower Total Interest: Interest is charged only on the remaining principal, reducing the overall cost compared to flat rate methods.
• Transparent EMI Structure: EMIs remain consistent throughout the tenure, giving borrowers clarity and predictability in financial planning.
• Faster Principal Reduction: Each EMI reduces the principal amount, accelerating repayment and lowering interest over time.
• Industry-Standard Calculation: Widely accepted for long-term loans, ensuring fairness and compliance with best practices.
• Ideal for Home Loans and Business Loans: Perfect for housing and business financing, offering affordability and structured repayment.
• Improved Financial Confidence: Borrowers gain assurance that repayments are fair and aligned with outstanding dues, supporting better financial control.
• Competitive Interest Rates: Lenders often provide attractive rates under this method, enhancing affordability.
• Clear Amortisation Schedules: Detailed schedules help borrowers track progress and plan prepayments effectively.

How Monthly Reducing Balance Impacts Your Loan EMIs and Interest

Under this method, EMIs remain constant, but the interest component reduces over time while the principal repayment increases. This leads to long-term savings and better financial planning. For Home Loan borrowers, this means predictable monthly outflows and reduced overall interest. Business Loan customers also benefit from improved cash flow management. Understanding this impact helps borrowers make informed decisions and optimise their repayment strategy.

Factors to Consider with Monthly Reducing Balance Loans

Before opting for this method, borrowers should review transparent loan terms, clear amortisation schedules, prepayment and foreclosure benefits, competitive interest rates, and borrower-friendly documentation. These factors ensure that Home Loans and Business Loans remain manageable and cost-effective throughout the tenure.

How to Calculate Your Monthly Reducing Balance EMI

Godrej Capital offers a Business Loan EMI calculator that helps borrowers estimate monthly payments and total interest under this method. By entering loan amount, tenure, and interest rate, users can plan effectively. This tool is invaluable not only for Business Loan applicants but also for Home Loan applicants seeking clarity and control over their finances.

Apply now for a Business Loan.

FAQs

Q.1. Is the Monthly Reducing Balance Method applicable to all types of loans?

A. Yes, it is commonly used for Home Loans and Business Loans.

Q.2. Can pre-payments affect interest in a Monthly Reducing Balance loan?

A. Yes, they reduce the outstanding principal, lowering interest.

Q.3. How is EMI split under this method?

A. Each EMI includes interest on the reduced principal and a portion of the principal itself.

Disclaimer:

The content presented on this page, including images and factual information, is intended solely as a summary derived from publicly available sources. GHFL/GFL (“Company”) does not claim ownership of such information, nor does it represent that the Companies have exclusive knowledge of the same. While efforts are made to ensure accuracy, there may be inadvertent errors, omissions, or delays in updating the content. Users are strongly encouraged to independently verify all information and seek expert advice where necessary. Any decisions made based on this content are solely at the discretion and responsibility of the user. Godrej Capital and its affiliates assume no responsibility for any loss or damage that may result from the use of or reliance on the information provided herein.