Flat rate vs reducing balance
With a flat rate, interest is worked out once, on the full loan amount, for the whole tenure. With a reducing-balance rate, interest each month is charged only on what you still owe, so it falls as you repay. That is why a flat rate always costs more than the same number as a reducing rate.
Flat interest = P × R × T ÷ 100
EMI = (P + flat interest) ÷ number of months. P is the loan, R the flat rate and T the tenure in years.
On ₹5 lakh at 10% flat for 3 years, interest is ₹1,50,000 and the EMI is ₹18,056. A reducing-balance loan with the same EMI would carry a rate of 17.92%, nearly double the flat rate.
How we find the real rate
We take the EMI and tenure of the flat-rate loan and find the reducing-balance rate that produces exactly the same EMI, using the standard EMI formula. If you add a processing fee, we do the same with the smaller amount you actually receive. This is the same idea as the APR shown on a lender's Key Facts Statement.
Questions people ask
Why is a flat rate so much higher than it looks?
With a flat rate, interest is charged on the full loan amount for the whole term, even though you repay part of it every month. By the last year you still pay interest on money you returned long ago, so the true cost is close to double the flat rate.
Where are flat rates used?
Mostly on personal loans from smaller lenders, two-wheeler and car loans from dealers, consumer durable loans and some microfinance loans. Banks usually quote reducing-balance rates for home loans and most personal loans.
What should I compare between two loan offers?
Compare the reducing-balance rate including fees (often shown as the APR on the Key Facts Statement lenders must give you). Two offers with the same EMI and tenure cost the same; a lower EMI for the same amount and tenure is cheaper.
Can I prepay a flat-rate loan to save interest?
Often less than you would expect. Many flat-rate loans charge interest for the full term upfront or levy a foreclosure fee, so check the terms before prepaying.
Method and sources
Flat interest = P × rate × months ÷ 1200; EMI = (P + interest) ÷ months. The reducing rate is the monthly rate r (× 12) at which P × r × (1+r)n ÷ ((1+r)n − 1) equals that EMI, solved numerically. With fees, P is reduced by the fee. EMIs are assumed at the end of each month. How we calculate.
Last reviewed 22 Oct 2026 by the WealthFeedz team.