Flat vs Reducing Interest
Compare flat interest rate vs reducing balance rate to understand the true cost of loans. Calculate EMI and total interest under both methods.
Loan Details
I know my rate as
Common in car loans, personal loans
Rate Conversion
10%
Flat Rate
17.3%
Reducing Rate
A 10% flat rate means you're effectively paying 17.3% reducing balance!
Same EMI Comparison
Monthly EMI
₹25.0K
Total Interest
₹5.00 Lacs
Why This Matters
Banks often quote "low" flat rates like 10% for car/personal loans. But this actually equals 17.3% reducing balance!
Compare this to home loans at 9-10% reducing - the car loan is actually more expensive.
Understanding Rate Types
•Flat Rate: Charges interest on original loan amount throughout the tenure
•Reducing Rate: Charges interest only on remaining balance (fairer method)
•Key Rule: Flat rate ≈ 1.7-2x the equivalent reducing rate (varies with tenure)
Turn These Numbers Into a Wealth Strategy
Our advisors specialize in cross-border wealth planning for NRI professionals. Get a personalized strategy based on your goals.
No commitment required. Free initial consultation.
All You Need to Know About Flat vs Reducing Interest
Flat Rate vs Reducing Balance Rate
When taking a loan, lenders may quote interest in two different ways: flat rate and reducing balance rate. Understanding the difference is crucial because they result in significantly different total costs.
Flat Rate: Interest is calculated on the original principal amount throughout the loan tenure.
Reducing Balance Rate: Interest is calculated on the outstanding principal, which decreases as you repay.
Why it matters: A loan advertised at 10% flat rate can actually cost more than one at 15% reducing rate! This calculator helps you compare apples to apples.
How Flat Interest Rate Works
Flat rate calculates interest on the original loan amount for the entire tenure:
Formula:
Total Interest = Principal × Flat Rate × Years
EMI = (Principal + Total Interest) / Number of Months
Example:
Loan: ₹10,00,000
Flat Rate: 10%
Tenure: 5 years
Total Interest = ₹10,00,000 × 10% × 5 = ₹5,00,000
Total Repayment = ₹10,00,000 + ₹5,00,000 = ₹15,00,000
EMI = ₹15,00,000 / 60 = ₹25,000
Key Point:
Even though you're paying down principal every month, interest continues to be charged on the full ₹10,00,000 as if you still owe the entire amount.
How Reducing Balance Rate Works
Reducing balance rate calculates interest only on the outstanding principal:
Formula (Monthly):
Interest = Outstanding Principal × (Annual Rate / 12)
EMI stays constant, but interest portion decreases each month
Example:
Loan: ₹10,00,000
Reducing Rate: 12%
Tenure: 5 years
Month 1: Interest on ₹10,00,000 = ₹10,000
Month 2: Interest on ₹9,88,000 = ₹9,880 (slightly less)
...and so on
EMI: ₹22,244 (calculated using standard amortization)
Total Interest: ₹3,34,667
Total Repayment: ₹13,34,667
Key Point:
As you pay down principal, less interest accrues. This is the fairer method used by most banks for home and vehicle loans.
Why Flat Rate Seems Lower
Lenders advertising flat rates often make loans appear cheaper:
Same Loan, Different Perceptions:
Loan: ₹10,00,000 for 5 years
Flat 10% vs Reducing 18%:
- Flat 10%: Total interest = ₹5,00,000
- Reducing 18%: Total interest = ₹5,03,000
They're almost equal! But flat 10% sounds much cheaper than reducing 18%.
The Conversion Formula:
Approximate Reducing Rate = Flat Rate × 1.8 to 2.0
(Varies based on tenure-longer tenure means higher multiplier)
Why This Happens:
- Flat rate ignores principal reduction
- You're paying interest on money you've already repaid
- The longer the tenure, the greater the distortion
Consumer Protection:
RBI mandates that lenders disclose the Annual Percentage Rate (APR) or Effective Interest Rate for transparency.
Where Each Rate Type is Used
Different loan types typically use different rate methods:
Reducing Balance (Standard):
- Home loans
- Car loans from banks
- Personal loans from banks
- Business loans from banks
- Education loans
Flat Rate (Watch Out):
- Vehicle loans from dealerships
- Consumer durables financing
- Some personal loans from NBFCs
- Gold loans (sometimes)
- Two-wheeler financing
Always Ask:
- Is this rate flat or reducing?
- What is the effective APR?
- What is the total interest payable?
- Can I get an amortization schedule?
Red Flag:
If a lender is reluctant to share the effective rate or total interest, be cautious.
How to Make the Right Choice
Use these steps to compare loan offers properly:
Step 1: Identify Rate Type
Ask explicitly: "Is this flat or reducing balance rate?"
Step 2: Calculate Total Cost
Use this calculator to find total payable under both methods.
Step 3: Compare EMIs
Higher EMI with lower total interest might be better than lower EMI with higher total interest.
Step 4: Consider Prepayment
- Reducing balance: Prepayment significantly reduces interest
- Flat rate: Prepayment benefits are limited
Step 5: Check Processing Fees
Include all fees in your comparison, not just interest rates.
Golden Rule:
Always compare TOTAL COST (principal + interest + fees), not just the stated interest rate.
Example Decision:
Flat 8% with ₹10,000 processing fee vs Reducing 14% with ₹5,000 fee
→ Calculate total payable for each and choose the lower one.
Tips for Loan Shoppers
Smart strategies for getting the best deal:
1. Always Ask for APR:
Annual Percentage Rate includes all costs and is comparable across lenders.
2. Get Quotes in Writing:
Verbal offers mean nothing. Get a written loan offer with all terms.
3. Use Amortization Schedule:
Request month-by-month breakdown showing EMI, interest, and principal.
4. Negotiate:
Interest rates are often negotiable, especially if you have good credit.
5. Consider Tenure Carefully:
Longer tenure = Lower EMI but higher total interest.
Shorter tenure = Higher EMI but lower total interest.
6. Check Prepayment Terms:
Can you prepay without penalty? This can save significant interest.
7. Compare Across Lenders:
Don't accept the first offer. Compare at least 3-4 options.
8. Read Fine Print:
Look for hidden charges, reset clauses, and other terms.