Flat interest rates and reducing balance interest rates are the two important approaches for calculating interest on a personal loan. Selecting between flat and reducing interest rates can significantly influence the overall interest cost, so it’s important to understand these options before signing an agreement for a personal loan.
Flat Interest Rate vs Reducing Balance Interest Rate
Flat Interest Rate
Interest is calculated on the original full loan amount, every single month, throughout the entire loan tenure.
Even after you have repaid half the loan, the interest continues to be charged on the original amount. You essentially pay for money you no longer owe.
- Interest amount stays the same every month
- Total interest paid is significantly higher
- Often used by some NBFCs and short-term lenders
Reducing Balance Interest Rate
Interest is calculated only on the outstanding loan balance, which reduces with every EMI payment you make.
As your principal reduces each month, the interest component of your EMI also reduces. You pay interest only on what you actually still owe.
- Interest amount decreases every month
- Total interest paid is lower
- Used by most banks in India
Comparison: Features at a Glance
Real Rupee Example: Same Loan, Same Rate, Different Cost
Flat rate charges interest on what you borrowed. Reducing balance rate charges interest on what you still owe. There is a big difference. This can be understood by following example, in which there is same loan amount, same interest rate, same tenure with a different method of calculating the interest rate.
Loan Details:
- Loan Amount: ₹3,00,000
- Interest Rate: 12% per annum
- Tenure: 3 years (36 months)
Important: A 12% flat rate loan costs you ₹49,296 more than a 12% reducing balance loan on just ₹3 lakh over 3 years. On a larger loan or longer tenure, this gap becomes even wider.
Understanding interest calculation is just as important as comparing Personal Loan Interest Rates.
Which One Should You Choose?
The reducing balance rate is the better choice in most of the cases, especially for personal loan more than ₹1 Lakh. It is cheaper, more transparent, and the rate you see is genuinely close to the rate you pay. A flat rate loan might be acceptable for a very small, very short-term loan (say ₹20,000 for 3 months) where the absolute rupee difference is minimal, and convenience outweighs cost.