Flat rate vs reducing balance
With a reducing-balance loan (almost all bank loans), interest is charged each month only on what you still owe. With a flat-rate loan, interest is calculated on the full original amount for the whole tenure, even though you repay part of it every month. The quoted number looks low, but you pay interest on money you've already returned.
Flat rates still appear in some car and two-wheeler loans, consumer durable finance, gold loans and microfinance. Advertisements often show only the flat rate because it looks attractive.
Interest = P × flat rate × years
EMI = (P + interest) ÷ monthsWorked example
A quick mental shortcut
For typical tenures of 1–5 years, the real rate is roughly 1.8–1.9 times the flat rate. So a "7% flat" car loan is really about 13% on a reducing basis. If another lender offers 10% reducing, that's the cheaper loan, even though its headline rate looks higher.
Protect yourself
- Ask directly: "Is this a flat rate or a reducing-balance rate?"
- Ask for the Key Fact Statement, which must show the annual percentage rate (APR) on a reducing basis.
- Compare using the EMI and the total amount repayable, not the quoted rate. The loan comparison calculator helps once you know the real rates.
Flat vs reducing at a glance
| Flat rate quoted | Approx. real rate (3-year loan) |
|---|---|
| 5% | about 9.3% |
| 7% | about 12.8% |
| 9% | about 16.2% |
| 12% | about 21.2% |
Use the calculator above for your exact loan amount and tenure.
Frequently asked questions
Is a flat interest rate illegal?
No, but lenders must disclose the annual percentage rate in the Key Fact Statement so you can compare it with reducing-balance loans.
Why do dealers offer flat-rate car loans?
The low headline rate makes the offer look cheap. The real reducing rate is usually much higher.
Does prepaying a flat-rate loan save interest?
Often very little, because interest was fixed on the full amount at the start. Check the foreclosure terms.