Reducing Balance vs Flat Rate Interest Rate
The interest rate quoted by a lender is meaningless unless you know the method used to calculate it.
Last updated: Aug 3, 2026
Flat Rate vs Reducing Balance
Flat Rate
Interest is calculated on the original loan amount for the entire tenure, even as you repay the principal every month. This means you keep paying interest on money you have already returned.
Reducing Balance (Reducing Rate)
Interest is calculated only on the outstanding principal after each EMI payment. As you repay principal, the interest portion decreases. This is the method used by almost all Indian banks for home, personal and car loans.
Side-by-Side Example
Loan amount: ₹5,00,000 · Stated rate: 10% p.a. · Tenure: 5 years (60 months)
| Particulars | Flat Rate (10%) | Reducing Balance (10%) |
|---|---|---|
| Monthly EMI | ₹12,500 | ≈ ₹10,624 |
| Total Interest | ₹2,50,000 | ≈ ₹1,37,411 |
| Total Amount Payable | ₹7,50,000 | ≈ ₹6,37,411 |
| Extra cost of flat rate | — | ≈ ₹1,12,589 more |
A 10% flat rate is roughly equivalent to 18% reducing balance in this example.
Quick Conversion Rule
(Exact multiplier depends on tenure)
Which Method Do Indian Lenders Use?
| Loan Type | Common Method |
|---|---|
| Home Loan | Reducing balance |
| Personal Loan (banks) | Reducing balance |
| Car Loan (banks) | Reducing balance |
| Two-wheeler / consumer durable | Often flat rate (especially dealer finance) |
| Gold Loan | Both methods exist |