What is Annual, Monthly reducing Balances?

Reducing balances means the time at which interest is calculated and applied to the Loan account. Repayments of home loans are by way of equated installments, paid every month. But housing finance companies adopt different modes of adjusting these monthly repayments towards the Loan accounts and to bring down the due Loan. In annual reducing balance method, the monthly repayments received from the borrower are kept in a suspense account and transferred to Loan account only once in a year (generally on 1st of April). To be more clear, if your Loan amount on 1st April, 2003 is Rs. 5,00,000/- and you pay monthly installments of Rs. 10,000/-, your entire payment of Rs. 1,20,000/- (10,000/- x 12 = 1,20,000/-) will be adjusted towards Loan amount only on 01/04/2004 and interest from 1.4.2003 to 31.3.2004 will be calculated on Rs. 5 lakhs. This works out very costly, as you will be paying the interest on Rs. 5,00,000/- for the entire 12 months. In case of monthly reducing, the repayments are credited to your Loan account on a particular day in a month, though you have paid much earlier. If any particular housing finance company has fixed 15th of every month, for such adjustments, and you have paid on 5th of the month, your Loan amount gets reduced only on 15th. Most of housing finance companies have shifted from annual reducing balance to monthly reducing balance. Most preferable mode is daily reducing type, where your Loan amount gets reduced on the very day of your payment.