Flat Rate vs Reducing Rate Interest Explained
When taking a loan, understanding whether the interest rate is 'flat' or 'reducing' (diminishing balance) can save you thousands. These two methods calculate interest very differently.
Flat Rate Interest
In flat rate, interest is calculated on the entire original loan amount throughout the tenure. If you borrow ₹1 lakh at 10% flat for 1 year: Interest = ₹1,00,000 × 10% = ₹10,000. Total repayment = ₹1,10,000. Monthly EMI = ₹9,167.
Reducing Rate Interest
In reducing balance, interest is calculated on the outstanding (remaining) principal each month. As you repay principal, the interest component decreases. For ₹1 lakh at 10% reducing for 1 year: Total interest ≈ ₹5,500. Total repayment = ₹1,05,500. Monthly EMI = ₹8,792.
Converting Flat to Reducing Rate
A rough conversion: Reducing rate ≈ Flat rate × 1.8 to 2.0. So a 10% flat rate is roughly equivalent to an 18-20% reducing rate! Always ask for the reducing rate (or effective rate) when comparing loans.
Which Is Common Where?
Car loans and personal loans often quote flat rates (which look lower). Home loans and credit cards use reducing balance (industry standard). Always compare loans on reducing rate basis for a true comparison.