Many borrowers focus on the interest rate quoted for a personal loan without checking how that rate is applied. Two loans with the same quoted rate can have very different total costs when one uses a flat rate and the other uses a reducing balance method.
A flat rate charges interest on the original amount throughout the tenure. A reducing balance rate charges interest only on the amount you still owe. On Rs. 2,00,000 over 24 months at 13%, a flat rate costs Rs. 52,000 in interest, compared with about Rs. 28,200 on a reducing balance.
What is the difference between a flat rate and a reducing balance rate
Lenders can calculate personal loan interest using different methods. A flat rate applies interest to the original loan amount throughout the tenure, while a reducing balance rate applies it to the outstanding amount after each EMI.
| Feature | Flat rate | Reducing balance rate |
| Interest is charged on | The original loan amount every month | The amount you still owe each month |
| Monthly interest over the tenure | Stays the same until the last EMI | Falls as the outstanding amount falls |
| Share of each EMI going to interest | Fixed | Higher at the start and lower near the end |
| Where you see it | Some dealer finance and informal lending | Standard EMI calculations and calculators |
How much more does a flat rate cost on a Rs. 2 lakh loan
On Rs. 2,00,000 over 24 months, a flat rate of 13% produces Rs. 52,000 in interest. A reducing balance rate of 13% produces about Rs. 28,200. The flat-rate EMI is also Rs. 992 higher each month.
These figures illustrate the difference between the calculation methods and do not represent any lender’s offer.
Take Ananya, 28, a graphic designer in Kolkata. She wants Rs. 2,00,000 for a new laptop and a motion design course. Two lenders quote her 13% for 24 months, but one uses a reducing balance method and the other uses a flat rate.
Before comparing the personal loan interest on two offers, check which method each lender uses.
| Item | Reducing balance at 13% | Flat rate at 13% |
| Monthly income (Rs.) | 55,000 | 55,000 |
| CIBIL score | 707 | 707 |
| Loan amount (Rs.) | 2,00,000 | 2,00,000 |
| Tenure (months) | 24 | 24 |
| EMI (Rs.) | 9,508 | 10,500 |
| Interest in month 1 (Rs.) | 2,167 | 2,167 |
| Interest in month 12 (Rs.) | 1,243 | 2,167 |
| Total interest over 24 months (Rs.) | About 28,200 | 52,000 |
| EMI as share of income | 17.3% | 19.1% |
| Equivalent reducing balance rate | 13% a year | About 23% a year |
The equivalent rate shows why the calculation method matters. For Ananya, the flat 13% rate costs about the same as a reducing balance rate of 23%.
What should you ask a lender about interest before you sign
Before signing a loan agreement, check how interest is calculated, how missed payments are handled and whether early repayment carries a charge. These details affect the total cost beyond the quoted rate.
- Check the interest method: Ask whether the rate is flat or reducing balance, and whether it is fixed or floating.
- Review the repayment schedule: Check how much of each EMI goes towards interest and principal.
- Check missed-EMI charges: Confirm the applicable penal charge rather than assuming a missed payment changes the interest rate.
- Check early repayment terms: Ask whether part-prepayment or foreclosure charges apply to your loan type.
- Compare other offers: If you receive an offer for personal loan for ladies, check its rate and charges against other offers using the same basis.
- Read the KFS: Check the annual percentage rate (APR), applicable charges and repayment schedule before signing.
How is interest on a loan worked out each month
On a reducing balance, monthly personal loan interest is calculated by multiplying the outstanding amount by the monthly interest rate. The monthly rate is the annual rate divided by 12.
For Rs. 2,00,000 at 13%, the calculation works as follows:
- Convert the annual rate: Divide 13% by 12 to get about 1.083% a month.
- Calculate first-month interest: Apply 1.083% to Rs. 2,00,000, giving about Rs. 2,167.
- Separate the EMI: From the Rs. 9,508 EMI, Rs. 2,167 covers interest and Rs. 7,341 reduces the principal.
- Recalculate the balance: The outstanding amount falls to Rs. 1,92,659, so the next month’s interest falls to about Rs. 2,087.
- Repeat each month: The repayment schedule shows how the interest and principal portions change across the tenure.
The reducing balance method therefore charges less interest as the outstanding principal decreases.
How can you check a lender’s interest calculation before signing
Understanding the calculation method helps you compare loans using their actual cost rather than the quoted rate alone. A flat rate continues to apply interest to the original principal, while a reducing balance method calculates interest on the amount still outstanding.
Before accepting an offer, enter the loan amount, interest rate and tenure into an EMI calculator. Compare the resulting EMI with the lender’s quoted EMI and check the repayment schedule and KFS. If the figures differ, ask the lender which input or charge accounts for the difference before you sign.
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