Monthly vs Daily Reducing Balance: Key Differences
Meeting your needs using a loan has become a common practice in India. People take different types of loans, including home loans, personal loans, vehicle loans, and business loans. Here, one should understand how to save their money on interest and balance. So, it is recommended to go for a reducing balance loan system rather than the conventional loan system. In a reducing balance system, the interest is charged on the outstanding loan only, and not the loan borrowed.
In this article, I will discuss the monthly reducing balance and the daily reducing balance, which are also the two main ones. Both of these forms are examples of what happens in the reduction of balance. I will also compare the monthly and daily reducing balance in order to enable the Indian borrower to select the balance that will save them the most money, particularly with the use of some more commonly offered loans, such as bank home loans of SBI, HDFC or Bajaj Finserv. If you want to understand the full calculation process, you can also learn how to calculate EMI in Excel step-by-step.
How Reducing Balance Works
Under a reducing balance loan, the interest rate is calculated on the remaining principal after every payment. First, your Equated Monthly Instalment (EMI) will cover the interest, and then the rest will be used to cover the debt. The interest that is to be paid in future decreases with a decrease in the principal and thus accelerates the repayment.
Important steps in how reducing balance works:
- Start with the entire principal of ₹30 lakh as a property loan.
- Interest per month = Balance x (Annual rate/12).
- An EMI payment reduces the principal after the payment, including interest.
- Now, the balance has reduced, and the interest rate for the following month is also less, as it will be charged on the newly reduced balance.
This method is more receptive and amiable to the borrowers compared to flat-rate loans, where the interest remains the same in the initial loan. You can compare different loan structures using loan comparison tool to understand total repayment differences.
Reducing Balance Loan Benefits
Mostly secured loans in India, such as home loans, vehicle loans and personal loans of large lenders, use reducing balance loans in their agreements.
Advantages include:
- Reduced overall interest: The lower the principal, the lower the interest rate, which is capable of saving lakhs in the long run.
- Promotes prepayments: Extra payments or part-prepayments will be funded at the same time to the principal, and the interest will be reduced immediately.
- Quick clearance of debts: The regular EMIs or additional payments reduce the effective tenure.
- Transparency: Borrowers can clearly see how much of their payment is directed towards interest and how much is directed towards the principal.
- Benefit of long-term loans: Loans for a house purchase that last 15 years to 30 years, where the savings accumulated with time are quite beneficial. If your loan starts with partial payments, it is important to understand what is pre-EMI and how it impacts early loan interest.
As an example, a 20-year 8.5% interest rate ₹50 lakh home loan would save a lot more with a declining balance, compared to alternative plans, which have a fixed rate.
Loan Interest Calculation: Monthly vs. Daily Reducing Balance
In India, the interest on loans is normally computed on the basis of the reducing balance technique, though the frequency may be monthly or daily.
Monthly Reducing Balance
It is the most common in India, where numerous banks and HFCs use it. The interest is charged on the balance carried over during the previous month.
- Monthly Interest = Existing principal × (Annual rate/ 12).
- At 8.5% with a ₹50 lakh loan, the interest will be approximately ₹35,417 in the first month. This is paid by EMI (approximately 43,391), and the rest is paid to the repayment of the principal.
You incur a small premium over a short period as you make prepays in the middle of the month, and they are not recorded until the following cycle, as it is recorded monthly.
Daily Reducing Balance
More friendly to the borrower (SBI applies it to home loans and certain other loans). The accumulation of interest is done on the balance at the end of each day and then at the end of the month.
- Daily Rate= Annual Rate/365.
- Monthly Interest= Sum of daily interest charges
- The prepayments reduce the debt immediately, which implies reduced interest on that particular day.
For example, when you put in ₹10 lakh in advance halfway through the month, the daily technique averages the lower balance, and so you reduce the amount of interest you would have paid that month by a large margin compared to the monthly method.
Comparison Table: Impact on a ₹50 Lakh Home Loan at 8.5% p.a. (20 Years, Approx. EMI ₹43,391)
| Aspect | Monthly Reducing Balance | Daily Reducing Balance |
| Interest Calculation Frequency | End of previous month | Daily on outstanding balance |
| Prepayment Benefit | Delayed (next EMI cycle) | Immediate (from prepayment day) |
| Total Interest (No Prepayment) | Similar (negligible difference) | Slightly lower |
| With Mid-Month Prepayment (e.g., ₹10 Lakh) | Higher monthly interest | Lower interest; faster principal reduction |
| Savings Potential | Baseline | Can save ₹50,000–₹2 lakh+ over tenure (especially with prepayments) |
| Common Lenders in India | Many HFCs and some banks | SBI, select banks |
It is not a great difference in the absence of prepayments since EMIs are paid monthly. Under prepayments (common in India on home loans), daily reducing savings save more since they involve reductions immediately.
Active borrowers who make extra payments or part-prepayments tend to save more when comparing monthly and daily lowering balances. Most professionals report that it is the most economical choice, yet monthly payments are the most common method of doing things, as they are simple.
FAQs
What is a reducing balance loan in India?
Only the balance available and outstanding is charged interest, on which a declining balance loan is charged, and this reduces with every EMI. This implies that the general interest rate is less than that of flat-rate loans.
What is the difference between a monthly reducing balance and a daily reducing balance?
The interest paid monthly is calculated based on the accumulated end sum of the prior month, and the interest paid daily is calculated based on the amount required to be paid on that day, which makes it more vulnerable to prepayments.
Among the monthly or daily reducing balances, which one saves more?
A daily reduction of balance tends to save more particularly when you make part-prepayments, as the interest charged will reduce immediately. Savings are not substantial without additional remuneration.
How do prepayments affect loan interest calculation in India?
In common practice, interest is reduced on that day through prepayments. The monthly payments have only benefits in the next cycle, and thus the cost is slightly higher.
Which Indian bank uses the daily reducing balance?
Banks, such as SBI, use a daily reduction of balance in the home loans, while others use a monthly reduction. Always read your loan agreement or enquire with the lender on how to do it.
Conclusion
In the case of the Indian borrowers, particularly home loan borrowers or those who wish to make additional payments, the best way to calculate the interest that they need to pay and the amount of money that they can save is by having their debt reduced every day. The most frequently used is the monthly lowering balance; it works with most EMIs, although daily is preferable. This will help you afford to save you a significant amount of money in interest over 15 to 30 years. The preferred method to reduce your balance according to your financial requirements is to compare deals between lenders, EMI calculators, and consider how convenient additional payments are. By using intelligent choices in this case, you will spend less money and be able to come out of debt sooner.
