Reducing balance vs flat rate

Two ways to apply a rate

• Reducing balance: each month's interest is charged on the balance outstanding at that time. As you repay, the interest falls. This is how the EMI calculator works.
• Flat rate: interest is worked out once on the full original amount for the whole term (principal × rate × years), added to the principal, and the total is split into equal instalments. You keep paying interest on money you have already repaid.

Side by side

₹1,00,000 for 12 months at 12%:

Flat interest: 1,00,000 × 12% × 1 year = ₹12,000, so each instalment is (1,00,000 + 12,000) ÷ 12 = ₹9,333.33.

The equivalent reducing rate is the reducing-balance rate that produces the same instalment. Solving the EMI formula for the rate (by trial, since there is no neat algebraic answer) gives about 21.46% a year: the flat 12% loan costs as much as a reducing-balance loan at nearly 21.5%.

A second example: ₹3,00,000 for 3 years at 10% flat. Interest = 3,00,000 × 10% × 3 = ₹90,000; instalment ₹10,833.33. At 10% reducing the instalment would be ₹9,680.16 with ₹48,486 interest. The equivalent reducing rate is about 17.92%.

How to compare loan offers

Ask each lender which method applies and compare like with like. For retail and MSME term loans, RBI's Key Facts Statement rules require lenders to disclose the Annual Percentage Rate, the annual cost of credit that includes the interest rate and all other charges, along with an APR computation sheet and the amortisation schedule (Source: Reserve Bank of India, checked 26 October 2026). Comparing APRs from the KFS avoids being misled by a low-sounding flat rate.