Understanding loan interest rates

One Sunday afternoon, I was at a chai stall in Lucknow when an old school friend, Rajesh, joined me. He looked stressed. Over sips of chai, he said, “Yaar, I thought I was paying just 9% on my shop loan, but now it feels like I’m paying for two shops!” That’s when I told him the truth—loan interest rates can quietly eat into your money if you don’t fully understand them.

They’re not just numbers printed on a loan paper—they’re the deal that decides whether you’ll finish your loan smiling or cursing.

Interest Rates: The Basics

Imagine this—you lend ₹1,000 to your neighbour Shalini. She promises to return it next month but says she’ll add ₹50 extra for the favour. That ₹50 is interest. The interest rate is just the percentage of the extra you’re paying for borrowing money.

Example: ₹5 lakh loan at 10% per year = ₹50,000 interest in one year.
 It’s nothing but rent for money. Just like a landlord charges rent for a house, banks charge rent for money.

Types of Interest Rates

Different banks, different tricks. And like picking from a thali menu, your choice changes everything.

• Fixed Interest Rate – Like a set menu in a restaurant. Your EMI stays the same, rain or shine. Great for those who like stability.
  
• Floating Interest Rate – This one’s like market vegetable prices—can go up or down depending on RBI’s repo rate changes.
  
• Reducing Balance Rate – Here, you pay interest only on the amount left to repay, so over time, the interest bill shrinks.
  
• Simple Interest Rate – Straightforward—interest only on your principal, no complicated maths.

Before you sign, ask the magic question: “Which one am I getting?”

The Impact of Interest Rates on Loans

My neighbour Sunita learnt this the hard way. She took a ₹10 lakh home loan for 10 years.

• At 8%, her EMI was about ₹12,133.
  
• At 10%, her EMI jumped to ₹13,215.

₹1,082 extra every month. Sounds small? Over 10 years, it’s more than ₹1.29 lakh—enough to buy a decent bike. That’s how interest rates turn tiny differences into big money over time.

Economic Factors Affecting Interest Rates

Interest rates aren’t decided by your bank manager sitting in an office—they move with the pulse of India’s economy.

• RBI Repo Rate – If RBI increases it, banks hike your loan rates too.
  
• Inflation – When prices rise too fast, interest rates usually go up to slow spending.
  
• Loan Demand – If many people are taking loans, lenders might adjust rates.
  
• Government Schemes – Programmes like PMAY can give lower rates to some borrowers.

In 2020, during the COVID lockdown, RBI cut repo rates sharply, and suddenly, many borrowers saw their EMIs shrink without doing anything.

Conclusion

A loan interest rate can be the difference between a peaceful repayment and years of frustration. A small percentage change might look harmless but can save or cost you lakhs.

So next time you take a loan, don’t just ask, “How much EMI?” Ask, “What’s my interest rate type? Can it change? How will it affect me over time?” In India, a little curiosity now can save you a lot of money later.

FAQs

1. How do you understand interest rates on a loan?

 It’s the cost of borrowing money, shown as a percentage. For a ₹1 lakh loan at 10%, you pay ₹10,000 interest in a year.

2. What does a 5% interest rate on a loan mean?

 You pay 5% of your loan amount each year. On ₹1 lakh, that’s ₹5,000 annually.

3. What does an interest rate of 7% mean?

For every ₹100 borrowed, you pay ₹7 interest yearly. On ₹10 lakh, that’s ₹70,000 annually.

4. What does 4% interest on a loan mean?

 It’s ₹4 per ₹100 borrowed annually. On ₹5 lakh, that’s ₹20,000 yearly.

Disclaimer : Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.