Flat vs Reducing Rate Converter

Two lenders offer a loan of 1,00,000 for three years. One says 8% a year. The other says 14.5% a year. The first looks far cheaper. If the first quotes a flat rate and the second a reducing-balance rate, they cost almost the same. Flat rates are common in some consumer, vehicle and microfinance loans, and in informal lending, and they are a classic way for a loan to look cheaper than it is. This page puts both on the same scale.

How a flat-rate loan is built

Interest is worked out once, on the original amount, for the whole term: principal × flat rate × years. Add it to the principal and divide by the number of months. For 1,00,000 at 8% for 3 years the interest is 24,000, the total is 1,24,000 and the instalment is 3,444.44 for 36 months. The catch is that each instalment repays some principal, so after a year you owe less, yet interest is still counted as if you owed the full amount.

How a reducing-balance loan differs

On a reducing-balance loan, interest each month is charged only on what is still owed. The standard EMI formula gives the instalment for a given rate. Because the balance falls, the same total cost corresponds to a much higher rate than the flat one. To compare, the page finds the reducing-balance rate whose EMI equals the flat instalment. There is no closed-form solution, so it searches by repeatedly halving a range until the two instalments agree.

A worked example

At 8% flat over 3 years the equivalent reducing-balance rate is 14.548%. With monthly compounding this is an effective annual rate of 15.558%, and the reducing rate is about 1.82 times the flat rate. The page checks itself by showing that the EMI at 14.548% is again 3,444.44. Going the other way, a loan at 12% on a reducing balance over 5 years is equivalent to a flat rate of 6.693%, with an instalment of 2,224.44, total interest of 33,466.69 and a ratio of 1.79.

Using it when you compare offers

Always ask a lender which type of rate it is quoting. If it says flat, convert it here and compare with other offers on the reducing-balance rate. Add processing fees separately, because they raise the true cost further. A flat rate is also easier to misjudge on longer loans, since interest is counted on the full amount for more years. For a car, bike or consumer loan, an apparently small flat rate can be dearer than a bank’s reducing rate.

Edge cases

Terms up to 40 years are accepted, fractions of a year too, rounded to whole months for the instalments. A flat rate of zero is allowed and gives a reducing rate of zero. Very high flat rates produce very high reducing rates, up to the limit of the search, which the page reports without complaint. A loan amount of zero is rejected.

Limits

The conversion assumes equal monthly instalments paid at the end of each month and no fees. Some lenders compute interest differently, for example by the day. The page cannot tell what your lender does, so use it to understand the offer, then check the loan agreement for the total repayable.

Related tools

• Loan Calculator produces a schedule when the rate is a reducing-balance rate.
• Simple Interest Calculator shows the plain interest formula behind a flat rate.
• No-Cost EMI Calculator examines another offer that hides its true price.
• Bike Loan Calculator applies EMI maths to a two-wheeler’s on-road price.