What Are Reducing Interest Rates in Businesses? A Complete Guide

Understanding loan rates is crucial for businesses seeking funds to expand, manage cash flow, or invest in new opportunities. The type you choose can significantly impact your repayment amount, total cost, and financial stability.

Business Loan typically come with two structures—fixed and reducing balance rates. Many businesses prefer the latter because they lower the repayment burden over time, allowing companies to save more as they clear their dues.

For small and medium enterprises (SMEs), startups, and growing businesses, selecting a lender that offers flexible repayment options and competitive reducing balance rates is essential. FlexiLoans, a leading digital lending platform, provides customised solutions with transparent terms, ensuring cost-effective financing.

What Is a Reducing Interest Rate?

Lenders charge interest only on the outstanding loan principal after each EMI (Equated Monthly Instalment) payment in a reducing balance structure, also called a diminishing balance rate. This method helps borrowers save over time because lenders calculate charges based on the remaining loan balance, unlike fixed-rate loans, where they apply costs to the total loan amount for the entire tenure.

How It Differs from a Fixed Interest Rate

1. Fixed Interest Rate
   • In this type of loan the lender calculates the total interest at the beginning, based on the full loan amount. The lender keeps the EMI (Equated Monthly Installment) constant throughout the loan tenure by calculating interest on the original principal amount without any changes.
2. • Downside: You end up paying more interest over time since the calculation is not adjusted as you repay the loan.
   Example:
   • You take a ₹10 lakh loan at 10% fixed interest for 5 years.
   • Every month, you pay EMI that includes a fixed interest component (based on ₹10 lakh) and a principal component.
   • Even as you repay the loan, the lender continues to calculate interest on the original ₹10 lakh, which increases the total interest payout.
3. Reducing Balance Interest Rate
   • Lenders recalculate interest each month in a reducing interest rate loan based on the remaining loan balance after each EMI payment.
   • As you repay each EMI, the principal amount decreases, which in turn lowers the interest charged over time.
   • Benefit: Over the loan tenure, you pay less total interest compared to a fixed interest rate loan.
   Example:
   • You take the same ₹10 lakh loan at 10% reducing interest for 5 years.
   • In the first month, the lender calculates interest on ₹10 lakh. After the first EMI payment, the outstanding balance reduces to ₹9.8 lakh, and the lender applies charges only on this new amount in the following month. This process continues, with the payable amount decreasing as the loan balance shrinks each month.
   • This gradually lowers the EMI amount because the interest portion decreases, and you repay more of the principal each month.

Key Takeaway

• If you prefer predictability and a fixed monthly EMI, a fixed interest rate loan is better.
• If you want to save on interest costs over time and pay lower EMIs as the loan progresses, a reducing balance interest rate is the smarter choice.

Example of a Reducing Balance Loan

A business owner secures a ₹10 lakh business loan from FlexiLoans at a 12% annual reducing interest rate for five years. Each month, the lender calculates interest only on the outstanding balance rather than the entire loan amount. As a result, the business owner saves a significant amount on interest over the loan tenure.

How Does the Reducing Balance Interest Rate Work?

When businesses opt for this loan, their EMI is divided into two components:

• Principal Repayment: Increases with each payment.
• Interest Payment: Decreases as the principal reduces.

Formula for EMI Calculation

Lenders calculate the EMI for a reducing balance interest rate loan using the following formula:

P×r×(1+r)n / (1+r)n – 1

Where:

• P = Loan Amount
• r = Monthly Interest Rate (Annual Rate ÷ 12 ÷ 100)
• n = Loan Tenure in Months

Example Calculation

For a ₹10 lakh business loan at 10% per annum with a 5-year tenure:

• Monthly interest rate = 10% ÷ 12 = 0.833% (0.00833 in decimal form)
• Using the formula, the initial EMI would be approximately ₹21,247.
• As the principal reduces over time, the lender charges less interest, which lowers the EMI.

Reducing vs. Fixed Interest Rates: Which Is Better for Businesses?

Both interest rate types have advantages and disadvantages. Understanding their differences helps businesses choose the best financing option.

Feature	Fixed Interest Rate	Reducing Interest Rate
EMI Amount	Stays the same	Decreases over time
Interest Calculation	On total loan amount	On outstanding principal
Total Interest Paid	Higher	Lower
Best for	Short-term loans, predictable payments	Long-term loans, cost-saving

Which One Should You Choose?

• Fixed Interest Rate: Suitable for businesses that need predictability in their payments.
• Reducing Interest Rate: Ideal for businesses looking to save on interest payments over time.

FlexiLoans offers reducing interest rate for business loans that ensure businesses pay less over time, improving cash flow management and financial flexibility.

Benefits of Reducing Interest Rate Loans for Businesses

1. Lower Interest Costs

Since lenders calculate interest on the outstanding principal, businesses pay significantly less over the loan tenure.

2. Affordable Monthly EMIs

The EMI amount reduces over time, easing the financial burden on businesses, especially those with fluctuating revenue.

3. Better for Long-Term Loans

Reducing balance interest rate loans are ideal for MSME loans, working capital loans, and equipment financing.

4. Encourages Early Loan Repayment

Businesses that have surplus cash can repay their loans faster without incurring excessive interest charges.

With FlexiLoans, businesses benefit from customised repayment structures that suit their financial capabilities.

Factors That Affect Reducing Interest Rates in Business Loans

1. Loan Amount & Tenure

A longer loan tenure results in more interest savings due to the reducing balance structure.

2. Business Credit Score

A higher credit score helps businesses secure better interest rates. FlexiLoans provides quick loan approvals for businesses with a strong financial profile.

3. Type of Lender (Banks vs. NBFCs)

Banks usually offer lower interest rates, but NBFCs like FlexiLoans provide faster approvals and more flexible repayment options.

4. Prepayment & Foreclosure Options

Reducing interest rate loans benefit from early payments, further lowering interest costs.

How to Calculate Reducing Interest Rate on Business Loans?

1. Use an Online EMI Calculator

FlexiLoans provides an easy-to-use business loan EMI calculator to help borrowers estimate their monthly payments and total interest costs.

2. Manual Calculation Example

For a ₹10 lakh business loan at a 10% reducing interest rate for five years:

• Monthly interest rate = 10% ÷ 12 = 0.833%
• Using the formula, the initial EMI = ₹21,247
• Over time, EMI decreases as the interest component reduces.

Conclusion

Reducing interest rate loans are a smart choice for businesses looking to minimise interest costs and improve financial stability. Unlike fixed interest rate loans, reducing balance loans ensure that the EMI burden decreases over time, making them more affordable in the long run.

FlexiLoans offers tailored business loan solutions with reducing balance interest rates, helping SMEs and startups access cost-effective financing. Whether you need funds for expansion, inventory, or working capital, a reducing interest rate loan can significantly lower your overall borrowing costs.