finance · 2 min read · India
A 10% flat rate is a 17.3% loan
On ₹5,00,000 over five years, a 10% flat rate produces an EMI of ₹12,500 and total interest of ₹2,50,000. The same repayments on a reducing balance basis correspond to a rate of 17.27%. Flat rate understates the true cost by 7.27 percentage points here.
A flat rate is charged on the amount you originally borrowed, for the whole term, whatever you have repaid. A reducing balance rate is charged on what you still owe. Since you owe less every month, the two produce very different amounts of interest from the same headline percentage, and the gap is wider than almost anyone expects.
| Basis | Rate quoted | Monthly payment | Total interest |
|---|---|---|---|
| Flat | 10% | ₹12,500 | ₹2,50,000 |
| Reducing balance, equivalent | 17.27% | ₹12,500 | ₹2,50,000 |
Read that table twice. The payments are identical and the interest is identical, because it is the same loan. Only the number on the advertisement changes. That is the whole trick: a flat rate is not a smaller cost, it is a smaller-looking way of quoting the same cost.
Why the gap is roughly double
Over the life of a level-payment loan you owe, on average, a little over half the original principal. Charging the original principal for the full term therefore collects roughly twice the interest that charging the outstanding balance would, at the same quoted rate. The rule of thumb is that a flat rate is somewhere near half the equivalent reducing rate, and it holds well enough to be useful: 10% flat is around 17% to 19% reducing on typical terms.
The multiple is largest on short loans. A 10% flat rate is about 18.2% reducing over two years, 17.3% over five and 16.7% over seven, because a longer schedule leaves more of the principal outstanding for longer and narrows the gap between the two ways of charging.
Where you will meet each one
- Vehicle loans, consumer durable finance and many gold loans are commonly quoted flat.
- Home loans and most bank personal loans are quoted on a reducing balance.
- A quote that gives you a monthly payment but never names a basis is worth converting before comparing it with anything.
The practical move is never to compare two rates without first establishing that they are quoted on the same basis. Convert the flat quote to its reducing equivalent, then compare. A lender quoting 10% flat against a bank quoting 14% reducing is the more expensive of the two, and the advertisement says the opposite.