Understanding Standard life Interest calculation method

Standard Life, like many other financial institutions, calculates interest based on the specific loan type. Each loan has its own interest rate and distinct calculation method. For example, the interest on an emergency loan is paid per flat, while salary loans and salary loan starter products use the reducing balance method

The Per Flat method is an interest calculation approach used by Standard Life Rwanda On emergency Loans, where the interest is calculated based on the requested loan amount, and the full repayment, including interest, is made in a single payment within a one-month period. 

A per flat interest calculation method (often referred to as a flat rate interest) is a simple way of calculating interest where the interest is charged on the entire loan amount (principal) for the full duration of the loan.

In the reducing balance interest calculation method, interest is applied to the outstanding loan balance rather than the original loan amount. This approach means that as the borrower makes regular payments, the principal (the amount still owed on the loan) decreases over time. As a result, the interest charged in each subsequent period also reduces, since it is based on the lower outstanding balance.

For example, if a borrower takes out a loan of RWF 1,000,000 at an interest rate of 7%, the first month's interest would be calculated on the full loan amount of RWF 1,000,000. After the borrower makes their first payment, the outstanding balance will decrease. In the second month, interest will be calculated on the remaining balance, not the original amount. This process continues with each payment, so the portion of the payment going towards interest decreases over time, while the portion applied to the principal increases.

This method offers a significant advantage to borrowers because it reduces the total interest paid over the life of the loan compared to flat-rate interest methods, where interest is always calculated on the original loan amount. The reducing balance method is particularly beneficial for loans with long repayment periods or large loan amounts, as it allows borrowers to save on interest as they progressively repay their loans.

Furthermore, this method is commonly used for various types of loans, such as mortgages, salary loans, and personal loans. It promotes faster repayment of the principal, which encourages borrowers to manage their debt efficiently. As the loan balance reduces over time, borrowers enjoy the benefit of lower overall costs, making the reducing balance method one of the more cost-effective ways to repay loans.

 Example: Reducing balance Interest calculations

key differences between the reducing balance and flat rate interest calculation 

Here are the key differences between the reducing balance and flat rate interest calculation methods:

1. Interest Calculation Basis:

• Reducing Balance Method: Interest is calculated on the outstanding loan balance, which decreases as you make payments. Each repayment reduces the principal, so the interest charged reduces over time.
• Flat Rate Method: Interest is calculated on the entire original loan amount for the entire loan term, regardless of how much has been repaid. The loan principal doesn't reduce for interest calculation purposes.

2. Total Interest Paid:

• Reducing Balance Method: The total interest paid is lower because the interest amount decreases as the loan balance reduces with each payment.
• Flat Rate Method: The total interest paid is higher because it is calculated on the full loan amount for the entire loan period, even as the principal decreases.

3. Monthly Installments:

• Reducing Balance Method: The monthly installments usually start higher and then gradually decrease as the interest portion becomes smaller over time.
• Flat Rate Method: The monthly installments remain constant throughout the loan period because the interest is calculated as a fixed percentage of the original loan amount.

4. Cost-Effectiveness:

• Reducing Balance Method: More cost-effective for the borrower in the long run, as interest payments reduce in line with the outstanding balance.
• Flat Rate Method: Typically results in a higher overall cost for the borrower since the interest is calculated on the entire loan principal for the full term.

5. Common Usage:

• Reducing Balance Method: Used for long-term loans like mortgages, salary loans, and personal loans.
• Flat Rate Method: Often used for short-term loans like emergency loans.

6. Transparency:

• Reducing Balance Method: Provides greater transparency as the borrower can clearly see the interest reducing with each payment.
• Flat Rate Method: Less transparent because the borrower pays a fixed interest amount based on the original principal, which may seem higher over time.

In summary, the reducing balance method is more borrower-friendly due to decreasing interest payments, while the flat rate method leads to higher interest costs due to its fixed nature.

For additional information, please visit our website at www.standardlife.org.rw or contact our support team at +250 788 195 000 or +250 794 426 634.