Flat Rate vs. Reducing Balance Interest: What's the Difference?
Understanding how interest is calculated is crucial for choosing the right loan. Our calculator helps you compare.
What is Flat Rate Interest?
Flat rate interest, also known as simple interest, is calculated on the original principal amount for the entire duration of the loan. This means the interest component of your EMI remains constant throughout the loan tenure, regardless of how much principal you've already repaid.
Loans like consumer durables loans, some personal loans, and car loans sometimes use the flat rate method.
What is Reducing Balance Interest?
Reducing balance interest, or diminishing balance interest, is calculated on the outstanding loan principal at the beginning of each payment period (usually monthly). As you repay your loan, the principal amount reduces, and so does the interest charged on the remaining balance.
Most home loans, personal loans from banks, and business loans operate on a reducing balance basis. This method is generally more beneficial for the borrower as the total interest paid is lower.
Key Differences and Why it Matters
The core difference lies in how interest is computed:
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Flat Rate: Interest is calculated on the *original* loan amount for the *entire* tenure.
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Reducing Balance: Interest is calculated on the *outstanding* loan amount, which decreases with each EMI payment.
This difference has a significant impact on your actual cost of borrowing. Even if a flat rate loan advertises a lower interest percentage, its effective annual rate (EAPR) is usually much higher than a comparable reducing balance loan.
Always ask lenders whether the interest rate quoted is flat or reducing balance before taking a loan. Our calculator helps you instantly see the financial implications of each method.