What are Flat and Reducing Interest Rates?
Lenders can charge interest on a loan in two ways. Under a flat rate, interest is charged on the full loan amount for the whole tenure, even though you repay part of it every month.
Under a reducing rate, also called a reducing-balance or diminishing rate, interest is charged only on the amount you still owe. As you repay the loan, the interest each month falls.
Because of this, a flat rate always costs more than a reducing rate of the same number. A loan quoted at a low flat rate can be more expensive than it looks.
What is a Flat vs Reducing Rate Calculator?
This calculator compares the EMI and total interest on the same loan at a flat rate and at a reducing rate.
Why you should use a Flat vs Reducing Rate Calculator?
- Compare loan offers: Turn a flat rate into its equivalent reducing rate before you compare it with other offers.
- See the real cost: See exactly how much extra interest a flat rate costs over the life of the loan.
- Ask the right questions: Know to ask your lender which method they use before you sign.
How Does a Flat vs Reducing Rate Calculator Work?
The calculator works on the following inputs:
- Loan Amount (P): The amount you borrow.
- Rate of Interest (R): The yearly rate quoted by the lender.
- Loan Tenure (T): The number of years over which you repay the loan.
Flat rate
Interest = P × R × T ÷ 100; EMI = (P + Interest) ÷ (T × 12)
Reducing rate
EMI = P × r × (1 + r)^n ÷ ((1 + r)^n − 1)
- P
- Loan Amount
- R
- Rate of Interest per year
- T
- Loan Tenure in years
- r
- Monthly rate of interest (R ÷ 12 ÷ 100)
- n
- Loan tenure in months (T × 12)
The equivalent reducing rate is the reducing rate at which the EMI equals the flat-rate EMI.
Flat vs Reducing Rate with an Example
Consider an example for a better understanding.
- Loan Amount: ₹5,00,000
- Rate of Interest: 10% per annum
- Loan Tenure: 3 years (36 months)
At a 10% flat rate:
Interest = 5,00,000 × 10 × 3 ÷ 100 = 1,50,000
The EMI is ₹18,056. At a 10% reducing rate, the EMI is ₹16,134 and the total interest is about ₹80,809 — about ₹69,191 less. The 10% flat rate is equal to a reducing rate of about 17.92%.
Things to keep in mind
- Check the method: Personal, car and two-wheeler loans are sometimes quoted at a flat rate. Home loans almost always use a reducing rate.
- Compare like with like: Always compare loans on their reducing rate, or on the total interest you will pay.
- Look beyond the rate: Processing fees and other charges add to the cost of a loan, whichever method is used.