Flat vs Reducing Rate — Which Interest Calculation Saves More?
Compare flat rate and reducing balance interest calculations. Understand why a flat rate of 10% actually costs more than a reducing rate of 18%.
Flat rate interest is calculated on the original loan amount throughout the tenure while reducing balance interest is calculated on the outstanding principal which decreases each month. A 10% flat rate on Rs 1 lakh for 3 years charges Rs 30000 total interest. The equivalent reducing rate is approximately 17.3% but charges only Rs 28500 in interest. Banks advertise flat rates because the number looks lower even though you pay more. Always compare using the effective annual rate.
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Key Information
| Parameter | Details |
|---|---|
| Flat Rate Formula | Interest on original principal throughout |
| Reducing Rate Formula | Interest on outstanding balance only |
| Conversion Factor | Flat rate x 1.8 ≈ Effective reducing rate |
| Which Costs More | Flat rate almost always costs more |
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Use Calculator NowFrequently Asked Questions
How to convert flat rate to reducing rate?
The approximate conversion: Reducing rate ≈ Flat rate x 1.8 to 1.95 (depending on tenure). A 10% flat rate ≈ 18-19.5% reducing rate. A 7% flat rate ≈ 12.6-13.7% reducing rate. This means a car dealer offering 7% flat rate is actually charging you the equivalent of 13% reducing rate which is much higher than a bank car loan at 9% reducing rate.
Why do dealers advertise flat rate?
Flat rates look lower: 7% flat sounds cheaper than 9% reducing even though 7% flat costs more. Many consumers do not understand the difference and choose the apparently lower rate. Personal loan apps NBFC and vehicle dealers frequently use flat rates. Banks and housing finance companies use reducing balance. Always ask whether the quoted rate is flat or reducing before comparing offers.
Which rate method is used for home loans?
All home loans in India use the reducing balance method which is regulated by RBI. This is fair because you pay interest only on the outstanding amount which decreases every month as you make EMI payments. Personal loans from banks also use reducing balance. However many NBFCs vehicle dealers and consumer finance companies use flat rates. The RBI has proposed making reducing balance mandatory for all loans.
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Last updated: March 2026