Fixed vs. Reducing Balance Interest, Explained
The same "12% interest" can mean two very different repayment totals. Here is how to read which one you are being offered.
When a lender quotes an interest rate, the method of calculation matters as much as the number itself. There are two common methods, and they are not comparable at face value.
Flat rate
Interest is charged on the full original principal for the entire tenure, regardless of how much you have already repaid. A 10% flat rate on a 1,00,000 loan over two years charges 10,000 every year — even in the final month when you owe almost nothing.
Reducing balance rate
Interest is recalculated each month on the outstanding balance only. As the principal shrinks, so does the interest portion of each EMI. This is how almost all home loans and most regulated personal loans work.
The rule of thumb
A flat rate of X% is roughly equivalent to a reducing-balance rate of 1.8X% to 1.9X%. So a 10% flat rate is close to an 18% reducing-balance rate. Always ask which method applies, and compare offers on the reducing-balance (APR) basis.
- Ask for the annual percentage rate (APR), which standardises the comparison.
- Ask for the total amount repayable over the full tenure.
- If only a flat rate is quoted, mentally almost double it before comparing.
This article is for general education and is not financial advice. Loan terms vary by lender and by your individual profile.
