Personal loan interest rates: what the number actually means

Reducing balance, annual. This is what a bank means by 12 percent. Each month, interest is charged at one-twelfth of the rate on the balance still outstanding. Because the balance falls with every EMI, so does the interest inside it: on ₹3 lakh at 12 percent over 36 months, the first EMI of ₹9,964 contains ₹3,000 of interest and ₹6,964 of principal; the last contains about ₹99 of interest. Total interest ₹58,715.

Flat, annual. Interest is calculated once, on the full principal, for the full tenure, and added to the loan before it is split into EMIs. On the same ₹3 lakh, a flat 10 percent is ₹30,000 a year for three years, ₹90,000, regardless of how much principal you have repaid by year three. The EMI is ₹10,833. The convention survives because 10 sounds cheaper than 18.

Monthly. Cards, pay-later products and some app-based lenders quote per month: 2 percent, 3.5 percent. The arithmetic is honest; the word 'month' does the work. Multiply by 12 and 2 percent becomes 24 percent a year, which is where it belongs in a comparison.

The clues are in the words: 'reducing balance' is the first, 'flat' or 'on the principal amount' the second, 'per month' or 'p.m.' the third. If none appears, ask, in writing.

Take ₹3,00,000 at a flat 10 percent over 36 months. Interest is ₹3,00,000 times 10 percent times 3 years: ₹90,000. Add it to the principal and divide by 36, and the EMI is ₹10,833.

Now ask what reducing-balance rate gives an EMI of ₹10,833 on ₹3,00,000 over 36 months. In a spreadsheet that is RATE(36, -10833, 300000) times 12. The answer is 17.92 percent. That is what the flat loan really charges, because that is what the same rupees would cost quoted the way a bank quotes them.

The gap is large because you never owe the full ₹3 lakh for three years: on a reducing schedule you hold roughly half of it on average, and a flat rate charges as if you held all of it. Over three years that makes the true rate about 1.8 times the flat rate. The multiple changes with tenure, so convert on your own numbers, not by rule of thumb.

A monthly rate is a reducing-balance rate on a shorter period, and if you pay every month it is simply twelve times itself. ₹3 lakh over 36 months at 2 percent a month has an EMI of ₹11,770 and costs ₹1,23,715 in interest, exactly what a bank quoting 24 percent per annum on reducing balance would charge.

If you do not pay, the unpaid interest joins the balance and next month's 2 percent is charged on that too. Compounded twelve times, 2 percent a month is 26.82 percent a year. On a card, 3.5 percent a month is 42 percent simple and 51.11 percent compounded. The monthly figure is small enough to read past; the annual one is not.

Personal loans in India are quoted across a wide band, from roughly 10.5 percent at a bank for a strong salaried profile to the mid-twenties from lenders pricing thinner files. Here is that band on ₹3,00,000 over 36 months, reducing balance, before any fee.

Banks price loans off a benchmark: an internal one that moves with what the bank pays for deposits (its marginal cost of funds based lending rate), or an external one, most often the RBI's repo rate. The loan rate is the benchmark plus a spread for the product and the borrower. When the repo rate moves, benchmarks move, and floating-rate loans follow at their next reset.

The question for a personal loan borrower is how much of that reaches you. A 25 basis point move, the usual size of a single policy change, takes ₹3 lakh over 36 months from 12 percent to 12.25 percent: ₹1,291 more interest over the whole tenure, ₹36 a month on the EMI, far below the processing fee any lender charges to refinance. Switching lenders because the repo rate fell a quarter point almost never pays; switching because your own rate is four points above what your profile now commands might.

Most personal loans in India are fixed-rate: the rate on the sanction letter holds for the tenure, and a repo cut after you sign does not lower your EMI, just as a rise does not raise it. Some lenders offer floating personal loans, and the letter will say which you have and what benchmark it tracks. A floating loan that is a quarter point cheaper today is a bet on rates staying put; a fixed loan is a price you know.

The regulator has already named that number. Lenders regulated by the RBI must give a borrower a Key Facts Statement before the loan is signed, and it must state an annual percentage rate: the all-in annualised cost, interest plus the charges the lender collects, alongside the EMI schedule. It is the one place the lender is obliged to state the rate in a single convention with the fee inside it.

To compare offers before a KFS exists, or to check one, the conversion is four steps. Identify the convention: a flat rate needs its EMI computed as principal plus flat interest, divided by months; a monthly rate goes into the EMI formula directly; a reducing annual rate is divided by 12 first. Get the EMI. Work out the cash you receive: principal, less the processing fee with 18 percent GST on it, less any insurance premium deducted at disbursal. Then solve for the rate that gives that EMI on that cash over that tenure: RATE(months, -EMI, cash received) times 12.

Five things to confirm before the rate on an app becomes the rate on a loan.